As vehicle expenses increase, employees may complain that their car allowance isn't enough. Some employers may try adding a fuel card or fuel reimbursement. Others may switch entirely to a mileage reimbursement or a fixed and variable rate car allowance (FAVR).
If you're already paying a monthly car allowance, adding a gas card or fuel reimbursement would be the more incremental approach. The company buys gas for the employees who drive personal vehicles for their jobs, in addition to providing a monthly stipend to cover other vehicle expenses such as insurance, maintenance, and depreciation.
Adopting a fixed and variable rate car allowance (a.k.a. FAVR reimbursement) would be a more radical approach. Reimbursement of fuel (based on mileage) would be factored into the payments, along with the other vehicle expenses. This approach requires access to expense data and proof of business use for vehicle expenses. But the result is a tax-free, cost-effective car allowance policy.
We'll explain below why FAVR is called "fixed and variable rate," and how exactly it works. For now, it's important to know that FAVR is a tax-free approach to boosting an employee car allowance.
Adding a fuel card or fuel reimbursement to an existing monthly car allowance is simple, at least at first. You give employees a credit card for gas purchases or you reimburse them for gas station receipts. That approach is easy to understand. But it's not as easy to administer as it sounds.
A standard car allowance is considered taxable income by the IRS. The same can also prove true of a gas card – unless you're willing to have employees track their business mileage to prove that the card is used only for business expenses.
But this is a personal vehicle, so some of that gas incidentally will be used for personal errands. There's still going to be gas in the tank after hours and on weekends. According to IRS rules, you have to either tax the portion for personal use or charge employees back for that portion.
This gets complicated. So maybe it's easiest to just keep it all taxable and not expend administrative resources on proving business use. But now you're providing a perk that subsidizes personal fuel use. How do you ensure that the added costs do not increase uncontrollably?
Controlling the costs of a gas card or reimbursement require additional rules of use, such as monthly caps or weekly restrictions on which days employees can buy gas.
Similar to a mileage reimbursement at or below the publish IRS rate, FAVR car reimbursements are non-taxable. But the problem with a typical mileage reimbursement is uncontrollable costs – the more employees drive, the bigger their reimbursement.
FAVR, however, provides cost control because it precisely reimburses all vehicle expenses. This is what makes this policy non-taxable. Also, while mileage is factored into the payment, it constitutes a lesser portion of the reimbursement, decreasing the incentive to drive extra miles in order to maximize payments.
While fuel is a variable expense – it rises and falls with miles driven and with gas prices – there are other vehicle costs that work differently. These are fixed costs that generally stay the same from month to month. Examples include car insurance, value depreciation, registration, and taxes.
Paying for employees' gas on top of a fixed monthly allowance acknowledges that these two types of expenses operate differently. But what sets FAVR apart is the use of data to reimburse both types of expenses precisely and tax-free.
Using expense data for a company-selected vehicle garaged in a specified zip code, a FAVR plan generates both variable and fixed rates of payment for each employee. The fixed rate is a set payment just like a standard car allowance. The variable rate is a cents-per-mile rate that adjusts with gas prices. The variable rate also takes into account other distance-based expenses like oil, tires, and maintenance.
Unlike a standard car allowance plus a fuel card or reimbursement, fixed and variable rate reimbursements are tax-free. The IRS publishes each year a set of guidelines for properly administering a FAVR vehicle allowance. Following these rules keeps all payments non-taxable.
The basic distinction between accountable and non-accountable comes down to proving business use. As we saw above, trying to prove business use of fuel can get very complicated. With FAVR, employees do have to log mileage to prove business use, but with today's GPS mileage apps, a complicated task becomes quick and simple. By basing all payments on localized expense data, the employer demonstrates that payments are reasonable reimbursements and not perks.
In order to properly operate a FAVR vehicle plan, most organizations opt to involve a third-party administrator. This is due to the complexity of generating fixed and variable rates using accurate data. At the same time, outsourcing tends to be a more cost-effective approach than paying a car allowance plus fuel.
The Achilles heels of car allowances and gas cards are tax waste and uncontrollable costs. Employees are losing 30-40% of that allowance to taxes – a huge chunk that would literally pay for their gas for the month. So why pay directly for the gas, an expense that will get uncontrollable without serious restrictions? Why not convert that tax waste into a payment that covers both gas and other vehicle costs?
It used to be that employees could at least recoup a lot of that tax withholding by writing off their business mileage on their tax return. But under the Tax Cuts and Jobs Act, that popular deduction is eliminated.
The alternative approach of FAVR reimbursement is going to prove a more cost-effective approach to this challenge. It's simple math.
By instituting an IRS-accountable, tax-free vehicle allowance, you take that money going to taxes and re-invest it in employees and the company's mission. No one gets under-reimbursed or over-reimbursed because the payments are precise. Most employees will see a boost in their allowance.
The company also saves many because it no longer pays payroll taxes on the car allowances – and you avoid the redundant expenditure on employee gas and the in-house administration of a gas card / reimbursement. Paying a FAVR allowance does not add administrative time because the savings are enough to outsource the program administration.
Best of all, it's a scalable solution that continues to work as the company grows in size and prices rise and fall. Because you're substantiating business use of the vehicle, all payments are tied to employee productivity. This cannot be said of a gas card (unless you go the complicated route).
Schedule an exploratory call to learn more about FAVR plan administration, or use the calculator below to see how much your business could save by switching to FAVR.