The fixed and variable rate allowance (FAVR) provides a tax-free, defensible, and cost-effective tool to offset employee vehicle expenses.
What is a FAVR car allowance?
A fixed and variable rate allowance (FAVR) is a tax-free way to reimburse employees for the business use of a vehicle they own or lease. This IRS revenue procedure combines periodic fixed payments and periodic variable payments to provide an accurate, localized vehicle reimbursement.
To properly administer a FAVR allowance, the employer must follow a set of IRS procedures that keep the program non-taxable to both the company and the employees. This approach holds several advantages over both a standard car allowance and a mileage reimbursement.
What are the guidelines for a FAVR allowance?
While the IRS has issued a number of guidelines for FAVR car allowances, two are most important:
- The FAVR allowance amount must be derived using a standard auto.
- The FAVR allowance amount must be derived from base locality costs.
Here's what those two guidelines mean:
First, rather than paying a standard allowance or mileage rate to all employees, the employer calculates the rate based on a standard vehicle – a vehicle of the same make and model for all employees, regardless of what vehicle they actually drive.
Second, the employer derives the FAVR allowance by approximating the actual expense amount an employee would incur driving that standard automobile in his or her zip code (i.e. the base locality).
Why does a FAVR car allowance use a standard automobile?
The standard vehicle provides a constant, while base locality costs vary. The goal is to reimburse employees for the appropriate level of business expenses. Different vehicles will drive expenses upward or downward (e.g. F-150 vs. Prius) but have no bearing on what the employer should pay, since that's a personal choice.
However, since employees are assigned different territories, and different territories experience different gas prices, insurance rates, and maintenance costs, it is necessary to factor in those variations to generate an accurate allowance.
How do fixed and variable payments work?
The fixed and variable allowance (FAVR) gets its name from the combination of fixed payments and variable payments. These two payments reflect the dual nature of vehicle expenses. All drivers experience both fixed costs and variable costs, and these are reflected in the expenses covered by a FAVR allowance.
Each employee receives a vehicle reimbursement schedule that pays the business use percentage of both types of costs:
The fixed monthly payment (like a standard car allowance) covers
- License fees
- Vehicle taxes (if applicable)
The variable payment (an adjustable mileage rate) covers
Why reimburse fixed and variable costs separately?
It is the combination of fixed and variable payments derived from applying base zip code costs to a standard auto that makes a FAVR allowance the most accurate, transparent, and defensible vehicle reimbursement approach available.
To see why, we'll compare a FAVR plan to standard car allowances and mileage reimbursements.
FAVR car allowance vs. standard car allowance
A standard car allowance pays the same amount to all employees without any substantiation of business use. This makes the payments taxable to both employee and employer. Employees who drive a lot get the same amount as employees who drive less. And employees who work in expensive places get the same amount as employees who work in more affordable places.
These circumstances guarantee that the allowance amount will not be fair to everyone. The employer may also be liable to lawsuits in states like California that require full reimbursement of employee business expenses through indemnification labor codes.
A FAVR allowance, however, is non-taxable and adjusts based on both employee mileage amounts and localized cost differences.
FAVR allowance vs. mileage reimbursement
A typical cents-per-mile reimbursement pays a standard rate to employees experiencing different costs. The payments are tax free as long as the mileage rate does not exceed the standard business rate published by the IRS (62.5 cents per mile in 2022).
But the standard rate applied to different employee costs creates problems. Employees who drive a lot will receive a large payment, possibly more than they need. Employees who drive less may find themselves under-reimbursed, since fixed costs like insurance, depreciation, and taxes/fees remain relatively unaffected by miles driven.
By separating fixed and variable costs for each zip code, FAVR solves these problems. In fact, FAVR was specifically designed for corporations to use for reimbursement of employees, whereas the IRS mileage rate was designed for use by individual taxpayers seeking to deduct business mileage.
FAVR allowances vs. state labor codes
Because FAVR allowance rates are transparent, scalable, and accurate, they comply with states that indemnify employees from company expenses. This benefit is particularly important for organizations with employees operating in California, Massachusetts, and other states with employee-friendly labor laws.
What other FAVR guidelines should I know?
The IRS has issued a set of requirements that define FAVR and delineate it as a non-taxable, or accountable, auto reimbursement plan. The vast majority of the rules are based on data modeling. Some of the better-known rules govern:
- Vehicle value
- Vehicle age
- Insurance requirements
- Annual business mileage
- Business use percentage
- Control employees participation
One important rule is that a company must have at least five employees receiving the FAVR allowance. There is, however, no maximum, except for the percentage receiving it at the management level. This keeps FAVR programs scalable for smaller businesses looking to grow.
Also, some FAVR requirements are customizable to company objectives. For example, if a company would like to control their image they can use nicer or newer vehicles to generate the reimbursement rates. This in turn would require employees to utilize nicer or newer vehicles.
How are FAVR vehicle plans administered?
Because FAVR regulations involve localized data, complex calculations, and change annually, it is best to have a third-party administrator design, implement, and manage your program (as opposed to self-administering). A trusted advisor that stays ahead of the tax code and has experience with administration can prove indispensable.
Switching from a traditional car allowance to a FAVR plan frees up significant financial resources by eliminating tax waste. This allows an organization to improve employee benefits and reduce overall expenses all while paying a third-party administrator.
Similarly, switching from the IRS mileage rate frees up resources by eliminating overpayments to high-mileage employees and reducing attrition due to the underpayment of low-mileage employees.
How to decide whether FAVR is right for you
Whether you use a car allowance or a mileage reimbursement or some combination, you will face challenging questions as you seek to offset employee vehicle expenses:
- Do you over-reimburse some employees and under-reimburse others?
- Are you and your employees losing money to unnecessary taxation?
- Are your employees happy with their car allowance or reimbursement?
- Are you able to control reimbursement costs and stay within budget?
- Does your plan violate state labor laws via insufficient reimbursement?
FAVR resolves these quandaries and simplifies reimbursement of employees for the business use of a personal vehicle.
mBurse specializes in helping organizations adopt and implement FAVR programs. Find out how your organization and its employees could benefit today by scheduling a discovery call or by using the calculator below.