How Does a Car Allowance Work?

Written by mBurse Team Member   |   Apr 17, 2023 5:45:00 AM
2 min read

Employees who drive a personal vehicle for work often receive a vehicle allowance to offset costs. Most people receive the allowance as a monthly lump sum. But does that monthly payment cover all business vehicle costs?

How does your monthly car allowance work?

A standard vehicle allowance is a monthly compensation for the costs of using a motor vehicle for work. This payment is typically part of a paycheck. It’s up to the employee whether to put that money toward a car payment or to use it to defray gas expense, wear and tear, and other car costs.

If you receive a standard car allowance, you don’t have to prove business use of the money or keep track of mileage. You just do your job and enjoy what essentially amounts to a perk. But problems can arise when your work-related driving costs exceed the amount of your allowance.

(Over 60% of employee drivers report this problem! See our annual survey results here.)

What is a car allowance supposed to cover?

Any vehicle reimbursement program should cover the costs of use and ownership, since the employee is required to possess a vehicle for the job.

Business vehicle ownership costs

Your car allowance should cover the business portion of the costs associated with owning a vehicle:

  • auto insurance
  • depreciation
  • registration/license
  • taxes

Business vehicle operation costs

Your car allowance also should cover the costs associated with driving your vehicle for work (distance-based costs):

  • fuel
  • oil
  • tires
  • wear-and-tear

Your business vehicle costs vs. your car allowance

If you drive a large SUV but only need a sedan or crossover to accomplish your job, then you can’t expect your allowance to keep up with costs. However, it is reasonable to expect your employer to cover all vehicle costs required of you to complete your job. In many states it’s required by law. 

Calculate your 2023 car allowance - for free

It’s important to know whether your allowance is keeping up with your business vehicle costs. Estimating the business costs of your vehicle and comparing these to your allowance is worth the time. Insurance and depreciation often constitute more than half of these costs, so make sure to include them. And make sure to compare your costs to the after-tax amount.

Are car allowances taxable?

A car allowance is taxable unless you substantiate business use of the payment. You can avoid taxation if you track business mileage and demonstrate that the allowance never exceeds the equivalent of the IRS business mileage rate ($.655 per mile for 2023). This is called a mileage allowance, or mileage substantiation.

You can also avoid taxation if your employer offers a fixed and variable rate car allowance. A FAVR plan uses localized cost data to accurately reimburse both the fixed costs of car ownership (insurance, registration/license, taxes, and depreciation) and the variable expenses like gas, tires, maintenance, and oil.

Both mileage allowances and FAVR allowances require significant administrative work, so most companies just pay a standard allowance. However, because taxes can eat up 30–40 % of your allowance, a non-taxable car allowance can make the complications worth it.

Can I track mileage to deduct from taxes?

Until the 2018 tax year, you could write off business mileage to offset the taxation of your car allowance. The tax reform eliminated this deduction, however, so you don't have to track your business mileage unless your employer gives a mileage allowance, pays a mileage or fuel reimbursement, or offers a FAVR car allowance.

It can still be worthwhile to track your mileage as you calculate whether your allowance is high enough. Multiply your monthly mileage by the IRS business mileage rate (65.5 cents per mile for 2023) to get a ballpark sense of average monthly vehicle expenses. The average American drives around 1,200 miles per year, so make sure to consider how close you are to that average, as well as whether your location is more expensive than average. (The IRS mileage rate is based on average mileage and costs.)

How much is a fair vehicle reimbursement

How much is a typical car allowance?

Even if you get a $600/month auto allowance, which is close to the IRS mileage rate payout at average mileage, taxes may render that amount insufficient. A fair car allowance covers all your costs of vehicle ownership and business travel in that vehicle – assuming you are using a reasonable vehicle for your job.

If, after calculating your expenses and subtracting taxes, you find out that your allowance isn’t keeping up, what do you do?

Depending on your work situation, this might be a great opportunity for an honest conversation with your boss. Or it may be worth encouraging co-workers to conduct the same analysis and see if a large number of employees are experiencing the same shortfall.

Tax-free vehicle allowances (FAVR plan)

Rather than simply asking for a higher vehicle allowance, the best solution may be to alert your employer to other reimbursement options besides a standard taxable car allowance. Often by switching to a tax-free, fixed and variable rate allowance, the company can save money and boost the vehicle benefit for employees. It’s a win-win because a FAVR car allowance converts all the wasted tax money into available funds.

For more ideas on how to help your company achieve a fair vehicle reimbursement, schedule a call with mBurse or check out our FAVR reimbursement info page.

Car allowance vs. FAVR Reimbursement

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