[UPDATED] From time to time, we like to feature a question we have received. This week, the question revolves around the difference between the Fixed and Variable Rate (FAVR) reimbursement and the company mileage rate or cents-per-mile reimbursement rate.
What's the difference between FAVR and the IRS mileage rate?
That's the essence of the question being asked below. But here's the full question so you get a sense of the company's situation:
Q: Our company has a couple hundred employees driving their own vehicles for business. We are currently reimbursing them for business mileage using the IRS mileage rate. The company mileage or cents-per-mile rate makes sense, so why bother with a more sophisticated program like the fixed and variable rate reimbursement rate?
In answering this question, we first clearly distinguished between the two types of programs.
Company mileage rate or cents-per-mile reimbursement
In a standard reimbursement program, management selects a cents-per-mile rate for employees, who then report business miles. In your case you elected to use the IRS mileage rate. The chosen mileage rate remains the same for all mobile employees no matter what their actual business costs are, no matter what vehicle they actually drive, and no matter how many business miles they actually drive.
The IRS mileage rate is a tax tool that typically only changes at the beginning of each calendar year, though there have been years (2008 and 2010) in which the rate was adjusted mid-year. (The IRS standard business rate for 2021 is 56 cents per mile.)
It remains up to your mobile employees to track, log, and report business miles. The mileage data is sent to either a person or system to be reviewed and approved each month. The data is then entered into a system and the employer reimburses employees using the current IRS mileage rate multiplied times the miles reported. The objective of this type of program is simplicity—one rate fits all.
But simplicity comes with a downside. Not all mobile employees actually experience the same costs, so a standard cents-per-mile rate can overpay some while underpaying others. Also, it’s important to remember that the IRS mileage rate is not designed to be a reimbursement guideline but instead a deduction guideline for taxpayers who do not keep precise records for business vehicle expenses.
Fixed and variable rate (FAVR) reimbursement
The fixed and variable rate allowance is an IRS procedure that considers all reimbursements as non-taxable expense offsets as long as guidelines are followed. This means your car allowance is not taxed as compensation. This reimbursement type was designed to be a corporate or business tool and not a personal tax tool.
As its title suggests, fixed and variable rate vehicle reimbursement consists of two components: a fixed monthly dollar amount and a variable reimbursement rate.
In order to determine the appropriate reimbursement, management, with the assistance of mBurse, selects the program parameters and standards for the business vehicle program based on needs that are unique to their company. mBurse’s extensive and unique databases for business vehicle costs then are used to generate suitable reimbursement rates for the employees.
The fixed dollar amount is used to address the fixed aspects of reimbursable costs (insurance, license, taxes, depreciation). However, while these costs may remain relatively stable for a single employee, they can vary between different employees working in different locations. Insurance rates, for example, can vary widely from state to state. Consequently, the dollar amount may vary by employee based on the zip codes where they garage and drive their car.
Similarly, because one mileage rate cannot address all employees’ needs, reimbursement rates are location-sensitive, taking into account differences in the costs associated with different territories. The reimbursement rate are also variable over time, rising and falling with expenses that fluctuate—like fuel prices.
As with a standard mileage rate, drivers report mileage for reimbursement. The big difference is that a FAVR rate can vary over time and by location, unlike the IRS rate.
Why FAVR reimbursements are superior to IRS mileage reimbursements
Overall, FAVR is a more accurate and sophisticated reimbursement program based on the company’s objectives, whereas the IRS mileage rate is a tax tool. A standard cents-per-mile rate is simple and convenient but too static to accurately and equitably reimburse employees.
When a company selects a third-party administrator like mBurse to develop a fixed and variable rate reimbursement program, the management actually enhances its ability to align reimbursement with company objectives. Management gets to set standards for vehicle use that reflect company priorities and then build around that.
The IRS mileage rate represents the average costs of owning and operating motor vehicles, based on last years average costs. A company adopting a fixed and variable rate vehicle reimbursement program can instead develop its reimbursement standards based on the current actual costs of owning and operating the type of vehicle most suitable to its work requirements.
Management also establishes the level of insurance coverage employees must carry to mitigate business risk and factor that expense into the reimbursement. The company can even set parameters around vehicle age, especially if image is important, and reimburse based on the expected age of the vehicle.
FAVR puts employer goals and employee needs first
Rather than starting with the reimbursement rate and applying it to all employees indiscriminately, the fixed and variable reimbursement rate approach allows management to start with the company’s priorities and the employees’ needs and build the reimbursement rate around it.
The ultimate goal of a FAVR program is an equitable, defensible reimbursement that is accurate and keeps up with current costs. By choosing FAVR, you choose to reduce company risk and protect mobile employees income as they travel for business. Plus, you choose a fairer approach that will over time promote good morale and help you retain valued employees.