The car allowance is one of the most overlooked business tools within most organizations. It seems simple enough and easy to maintain. But the simplicity of a standard monthly payment carries hidden costs for both employers and employees, especially when gas prices are high.
How much is a standard car allowance?
The annual mBurse Car Allowance Survey found that most companies (68%) paid employees between $500 and $700 per month to defray vehicle costs incurred as part of their jobs. The average was right around $600. This monthly stipend is meant to cover a variety of costs, including gas, maintenance, insurance, depreciation, and more. (For more on this, read "What Does a Car Allowance Cover?")
For many organizations, this is a relatively small cost, especially given the importance of the work these mobile employees use their vehicles to accomplish: making sales calls, building client relationships, delivering goods and services to clients, etc. Even when boosted to address high gas prices, car allowances still amount to a fraction of an organization's budget.
But the hidden costs of a typical car allowance can add up in ways that reduce the true value of the monthly stipend, ways that prove detrimental to both the company and the employees. Most organizations, however, leave their allowance amount unreviewed and unchanged for years, and the additional costs remain hidden and unaddressed.
What do they do when gas prices suddenly spike, as they did in March of 2022? It turns out that this is a small problem compared with two bigger yet hidden problems.
The hidden costs of a typical car allowance
The true cost of a car allowance falls under two categories: taxes and undesirable employee behavior. An improperly calibrated vehicle reimbursement creates liabilities in both areas. Let's explore.
The true cost of a taxable car allowance
Most standard car allowances are considered taxable income by the IRS. Unless the company pursues an accounting procedure that proves business use of every dollar paid to employees to offset vehicle costs, the car allowance is considered a non-accountable plan and subject to both federal and state taxes. (How to Keep Your Car Allowance Accountable, or Non-Taxable)
When you add up federal income taxes, FICA, and state income taxes, the car allowance can be reduced by as much as 40%. A $600 monthly payment suddenly is worth only $360. Unless an employee drives a minimal amount each month, it is unlikely that $360 will cover the business portion of his or her vehicle expenses.
Remember also that the employer must pay its portion of FICA for each employee. So not only do the taxes cost the employee, they also cost the company.
It is important to also know that, while in the past employees could recover some of the tax withholding by deducting business mileage on their tax return, the 2017 Tax Cuts and Jobs Act removed this deduction for the 2018-2025 tax years. So now employees that receive a taxable car allowance have no recourse to recover lost income – unless they work in a state that allows them to sue their employer for insufficient vehicle expense reimbursement. (California, Illinois, Massachusetts, and a handful of other states.)
When workers realize they are not receiving an equitable vehicle allowance or reimbursement, they often take steps to minimize their losses. And these steps typically carry additional costs for the company.
How car allowances create costly employee behavior
Employees who receive a flat, taxable auto allowance often take steps to maximize their benefits to the detriment of the company. They may forgo face-to-face meetings that require travel and replace them whenever possible with phone calls, webinars, and other sales tactics that aren’t as effective as an in-person meeting. As a result, they pocket a larger portion of their auto allowance, but their reduced effort with clients costs the company.
Some companies try to remedy this problem by reimbursing employees per mile driven instead. But this still often doesn’t provide a cost-effective solution. When employees are asked to record and report their mileage, most find it tedious to keep track of the exact figures and provide estimates instead. And with these estimates, let's be honest – most people are going to round the figures up. The result? Your company pays for miles not actually driven.
Similarly, morale can dip when employees do not feel that they are treated fairly. Because they each receive the same monthly car allowance, regardless of how many miles they drive or whether they work in a more expensive region, some employees may be under-reimbursed while others are over-reimbursed. (This tends to be a problem with mileage reimbursement programs as well.)
These employees are more likely to look for new employers with more robust vehicle reimbursement policies. Our survey found that 88% of HR managers had heard complaints about the company's car allowance amount, and 92% of mobile employees affirmed that a company's vehicle reimbursement program was "very important" (79%) or "somewhat important" (13%) when considering employment.
The cost of replacing employees and training new employees adds up, along with the reduced productivity from employees who are unhappy with their vehicle allowance. In states with employee-friendly reimbursement laws, employees may even sue their employer or report labor code violations. They may even reduce their car insurance coverage to save money, which can leave the employer liable if the employee causes an accident during work hours and their insurance cannot cover the costs.
These various costs can add up and cost a company millions of dollars over time. But most businesses don’t notice the connection with their car allowance policy and fail to realize that some relatively inexpensive changes could prevent significant long-term costs.
The importance of a non-taxable, data-driven car allowance
One of the easiest ways to eliminate the hidden costs of a standard car allowance is to switch to a non-taxable plan. Many organizations think it is as simple as switching to a mileage reimbursement program, since reimbursements at the IRS business rate or less are considered non-taxable (62.5 cents per mile for 2022).
However, mileage rates carry hidden costs as well and often prove even more expensive for companies while not always sufficiently reimbursing low-mileage drivers, and mid-mileage drivers who work in expensive locations.
The keys to developing a non-taxable, accountable car allowance are two-fold:
1.) use a standard vehicle to generate reimbursements, rather than a standard rate or amount.
2.) use vehicle expense data for each employee's garage zip code to accurately predict each employee's vehicle expense needs.
Data exists that can allow a company to reimburse mobile employees accurately and fairly. The best part is, it's not as difficult as it might sound. With the right tools, your organization can offer a data-driven car allowance that increases productivity and cuts costs.
Many employers think the way to ensure fairness is to make all employees’ auto allowances equal. However, equal is not necessarily equitable. Consider companies that span large portions of the country. Gas prices and maintenance costs are much higher in California and Washington than in Texas and Oklahoma. So to give employees in Los Angeles the same allowance or mileage rate as employees in Houston is equal, but unfair.
It’s time to find a better way. It's time to base reimbursement on hard data that accurately and equitably compensates mobile employees. This data exists, and with the right tools, your company can offer fair and cost-effective car allowances.