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?
What is a car allowance, and how does it 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 reported this problem on our 2019 survey! See the results here.)
What does a car allowance cover?
Any vehicle reimbursement program should cover both vehicle use and vehicle ownership, since the employee is required to possess a vehicle for the job. That means your vehicle allowance must cover your car insurance, depreciation, taxes, registration and license, gas, oil, tires, and maintenance.
Of course, if you drive a large SUV, but you only need a mid-size 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 fact, in many states it’s required by law.
It’s important to know whether your allowance is keeping up with your business vehicle costs. Insurance and depreciation often constitute more than half of these costs, so make sure to include them. Consider using our vehicle cost calculator, but when you compare the result to your allowance, make sure to compare it to the after-tax amount if your payment is taxed.
Are car allowances taxed?
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 ($.56 per mile for 2021). 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 reimburses the fixed costs of car ownership (insurance, registration/license, taxes, and depreciation) with a monthly payment equivalent to the costs of a reasonable vehicle for your job. In addition, you receive a variable mileage rate to offset 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.
Should I track mileage to deduct from taxes?
Even though a standard car allowance does not require you to track mileage, many employees do so for tax purposes. Until the 2018 tax year, you could write off business mileage to offset the taxation of your car allowance. You just multiplied the mileage by the IRS mileage rate, and as long as the amount exceeded 2% of your adjusted gross income, you included it in your itemized deductions.
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. But it can be worthwhile to track your mileage as you try to figure out whether your allowance is high enough.
Multiply your monthly mileage by the IRS business mileage rate (57.5 cents per mile for 2020) to get a ballpark sense of average monthly vehicle expenses. The average American drives 13,476 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 (gas, insurance, etc.).
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.
A non-taxable vehicle allowance (FAVR vehicle program)
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.