Car allowances are often underestimated as a business tool in many organizations. They appear straightforward and easy to manage. However, the apparent simplicity of a regular monthly payment conceals hidden expenses for employers and employees, particularly during periods of inflation.
How much is a typical 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 around $600. This monthly stipend covers gas, maintenance, insurance, depreciation, and more costs. (See also "What Does a Car Allowance Cover?")
For many organizations, this is a relatively small cost, given the importance of the work these mobile employees use their vehicles to accomplish: sales calls, service calls, client visits, deliveries, etc. Even when adjusted to match inflation, car allowances amount to a fraction of an operations budget.
However, the hidden costs of a typical car allowance can add up and reduce the vehicle stipend's actual value. 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 (like in 2022) or insurance premiums rise 20% (as they did in 2023)? These are the visible costs. The hidden costs are more significant.
The hidden costs of a typical car allowance
The actual 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 actual cost of a taxable car allowance
Most standard car allowances are considered taxable income by the IRS. Unless the company pursues an accounting procedure proving business use of every dollar paid to employees to offset vehicle costs, the car allowance is considered a non-accountable plan and subject to federal and state taxes. (Find out how to make your car allowance accountable.)
When you add federal income taxes, FICA, and state income taxes, a 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 their 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, but they also cost the company.
It is important to remember that, under the current tax code, employees cannot deduct business mileage on their tax returns. Only self-employed drivers can do that. Employees who 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. These steps typically carry additional costs for the company.
How car allowances create costly employee behavior
Employees who receive a taxable auto allowance often take steps to maximize their benefits to the company's detriment. They may forgo face-to-face meetings and replace them with phone calls, webinars, and other sales tactics that aren’t as effective as in-person meetings. This reduced effort with clients costs the company over time.
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, they may provide estimates instead or exact figures. These estimates can be conveniently rounded up, adding significant costs over time.
Similarly, morale can dip when employees do not feel treated reasonably. 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.
When a car allowance is perceived as insufficient or unfair, the following costly consequences can ensue:
- Reduced productivity
- Increased attrition (rehiring costs are very high)
- Labor code lawsuits (in employee-friendly states)
- Reduced insurance coverage (creates liabilities when an underinsured employee causes an accident on the job)
Over time, these accumulated expenses can lead to a company losing millions of dollars. However, many businesses overlook the link between their car allowance policy and these costs, missing the opportunity to implement low-cost changes that could avert substantial long-term expenses. A straightforward approach is to gather benchmarking data from organizations and competitors of similar size.
The importance of a non-taxable, data-driven car allowance
One of the simplest 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 non-taxable.
However, mileage rates have hidden costs as well. They often prove even more expensive for companies and do not always sufficiently reimburse low-mileage and mid-mileage drivers who work in expensive locations.
The most cost-effective way to reimburse employees tax-free is a FAVR allowance. Two key distinctions of a FAVR allowance make it fairer and more accurate:
1.) Uses a standard vehicle to generate reimbursements rather than a standard rate or amount.
2.) Vehicle expense data for each employee's garage zip code is used to predict each employee's vehicle expense needs accurately.
With the right tools, your organization can offer a data-driven car allowance that increases productivity and cuts costs. You can start using our policy assessment tool, which provides benchmark data to show your car allowance and how much you could save by going tax-free.