Most businesses experience both fixed expenses and variable expenses. Knowing the difference is important, especially if your organization reimburses employees for their business vehicle expenses.
Whether you are operating a business or managing a household budget, you have encountered both fixed and variable expenses. A fixed expense stays relatively unchanged each month, regardless of business output. A variable expense changes frequently based on output or market prices. A "fixed and variable rate" reimbursement is a business reimbursement that accounts for both expense types.
Examples of fixed costs: mortgage and loan payments, insurance premiums, rent, salaries, cell phone bills, property taxes, vehicle license.
Examples of variable costs: hourly wage payments, sales commissions, taxes on income and sales, fuel, raw materials, utilities.
It is important that all businesses take both sets of costs into account when budgeting, determining economies of scale, setting prices, and pursuing growth. It is also vital that any organization that reimburses employees for the use of a personal vehicle distinguish between fixed and variable costs.
Looking to calculate a fair, affordable car allowance or mileage rate? Here's how to set the proper amount. Or get your rate calculated for free:
When it comes to company vehicle programs, such as mileage rates, car allowances, or company cars, it is vital to design the program with both sets of expenses in mind. Otherwise, negative consequences can ensue:
So what vehicle expenses fall under each category?
Fixed vehicle expenses are the costs that come with owning a vehicle, whether you drive it a lot or a little. These costs remain relatively stable from month to month or even year to year:
Does your company mileage reimbursement take into account insurance and depreciation? These often constitute over 60% of annual vehicle expenses, but often are not properly reimbursed by mileage rates.
The variable expenses for a vehicle could be considered operation costs. Driving more or less will have a significant impact on these costs, as do fluctuations in market prices:
Standard car allowances remain the same from month to month and even year to year. Our annual surveys have typically shown that the majority of employers only update their car allowance amount every 7 to 10 years.
Paying an equal amount every month can offset fixed expenses, since they are predictable and stable. Paying an equal amount every month cannot accurately offset variable expenses, especially when gas prices fluctuate dramatically or workers' business mileage fluctuates widely.
But even in times of more predictable variable expenses, standard car allowances create inequities across the company. This is because different employees drive different amounts, face different localized gas prices and maintenance costs, and cover different sized territories. But they each receive the same monthly allowance.
It is also important to note that standard car allowances are taxable, which can mean that an employee only receives 60-70% of the allowance after taxes. This is why car allowances often leave workers undercompensated for their vehicle use and may violate labor codes in states like California that require full reimbursement of business expenses to employees.
Since variable costs increase with increased travel, it makes sense to reimburse employees per mile, right? The problem is, mileage rates tend to under-reimburse fixed costs. Here's why:
If a driver is reimbursed per mile, then that driver needs to drive a certain number of miles in order to cover all fixed costs before the mileage reimbursement starts to cover the driving-based costs. And the driver must drive an additional number of miles in order to catch up to those variable costs. What if the driver does not drive enough?
Or, what if the driver covers a large territory and consistently accrues far more miles than necessary to recoup all work-related car expenses?
A form of vehicle reimbursement exists that can accurately reimburse both sets of costs. In fact, the name specifies both. The IRS calls it a fixed and variable rate allowance. This procedure blends the concept of a car allowance to pay fixed costs and a mileage rate to pay variable costs.
The fixed and variable rate allowance, or FAVR, delivers tax-free payments to employees when administered effectively. The hallmarks of a FAVR reimbursement program include
When an organization chooses to switch to a FAVR reimbursement model, the benefits are often felt quickly. In general, these benefits include
There are also benefits specific to whether you switch from a traditional car allowance or a mileage reimbursement like the IRS rate:
A FAVR vehicle program can be challenging to administer at first because of the IRS regulations involved. But with the right guidance and support it can be done cost-effectively.
To learn more about how a fixed and variable rate allowance could work for your organization, you may schedule an exploratory call, use the mBurse FAVR savings calculator, or take a deep dive with our ultimate guide to FAVR reimbursements.