As car allowances have undergone increased scrutiny over the past year, more businesses are learning about the Fixed and Variable Rate (FAVR) reimbursement. This IRS-approved alternative to a standard car allowance or mileage rate accurately reimburses employees for the expense of operating a personal vehicle for work.
In the wake of the tax reform and recent changes to state labor codes, more organizations are re-evaluating their car reimbursement policies. The following Q & A will help you evaluate whether a FAVR vehicle program could benefit your organization.
The FAVR reimbursement defined
The fixed and variable rate car reimbursement is best categorized as a non-taxable vehicle reimbursement. The IRS has created a set of procedures that keep a car reimbursement plan non-taxable. Section 8 details these guidelines for FAVR reimbursements.
This expense offset plan reimburses mobile employees exactly how they incur costs. Employees receive a fixed amount each month to cover fixed costs like
Employees also receive a variable amount to cover variable costs:
FAVR reimbursement benefits
While still relatively unknown too many organizations that pay a car allowance, fixed and variable rate is increasingly considered best practice for organizations with mobile employees that travel 5,000 or more miles a year. This is because standard allowances and mileage rates involve inherent flaws that require a more sophisticated plan to correct. Flaws of typical business vehicle plans include
- Significant amount goes to taxes (traditional car allowance)
- Difficulty controlling costs (especially with IRS mileage rate)
- Paying the same amount or rate to employees operating in different parts of the country or driving significantly different distances
- Inability to accurately address both large fixed costs (e.g. depreciation and insurance) and variations in operational costs (e.g. gas prices)
Alternately, following IRS guidelines for fixed and variable rate reimbursement brings five important benefits:
- No taxes—all of the payment goes to reimbursement
- The reimbursement rates are based on data
- Geographically cost sensitive/ able to address cost variances
- Completely customizable and flexible
- Control business costs while providing an equitable reimbursement
Why more businesses are using FAVR
I am sure you are asking the questions if FAVR is so great why don't more businesses use FAVR as their reimbursement policy? Even though the majority of organizations are still reimbursing with outdated and inaccurate policies because for the sake of convenience and simplicity, FAVR is on the rise. A standard vehicle allowance or mileage reimbursement (such as the IRS business mileage rate) is easy to compute and easy to pay out. And let’s be honest, most of us like to stick with the way things have always been done rather than exert the time and effort required to make policy changes.
When businesses find that their vehicle reimbursement policy is creating problems, such as under-reimbursement or over-reimbursement, they often just add other components, rather than re-evaluate the whole policy. These components often take the form of
- Car allowance + fuel reimbursements or fuel cards
- Car allowance + mileage reimbursements
- Mileage allowances (mileage substantiation)
However, though simple and easy to administer, these DIY vehicle reimbursement programs often work against business objectives and increase the organization’s risk over time.
Typically, when people first hear about a non-taxable car allowance with a reimbursement, they think it’s a tax loophole or simply not true. It may sound too good to be true, but FAVR plans can literally solve nearly every vehicle reimbursement problem organizations commonly face.
Why should my business switch to a FAVR vehicle program now?
A result of the tax reform we can no longer write off unreimbursed business expenses. As a result this has made vehicle reimbursements more of a priority. It is more important than ever that employees are reimbursed accurately and most importantly not taxed. Your car reimbursement will actually affect your attrition rates.
In the past, receiving a car allowance meant you could claim a tax deduction on your business mileage. With the loss of this substantial deduction, employees in 2019 will take numerous measures to secure their income. They may raise complaints with their employers, drive less to save money, drive more (if they receive a mileage reimbursement), or find employment at a competitor with a more equitable reimbursement plan.
Compounding the tax reform changes are states with expense indemnification clauses. More states are adding clauses to their labor codes that ensure employees are reimbursed properly for out of pocket expenses. In the upcoming years we will see an uptick in the number of expense indemnification lawsuits as well as states adopting these laws. Penalties and fines under state labor codes will likely increase as the tax reform increases the attention on equitable reimbursement practices.
The truth is, a standard vehicle allowance or mileage rate just won’t cut it on this side of the tax reform.
How is FAVR administered?
Even though a FAVR plan sounds complicated it really isn't. To properly deliver a fixed and variable rate allowance, most organizations outsource administration to a third party. The IRS has instituted 28 rules that make FAVR reimbursements accountable plans, which adds to their complexity. The majority of the rules involve data modeling and the geographical cost designs. Think of a FAVR vehicle program as similar to healthcare. Most companies outsource their healthcare benefits rather than trying to administer them internally.
Fortunately, because of the elimination of tax waste and the accuracy of the reimbursements, switching will more than cover the costs of third-party administration. In fact, most companies realize significant savings during the first year.
To learn more about how FAVR could help your business meet its objectives, contact mBurse today.