How do you know if your company vehicle allowance amount is fair to employees? The answer is not to compare it to the average number of vehicles nationwide.
Quick Answer: How Much Is a Fair Vehicle Allowance?
A fair vehicle allowance should cover the reasonable business-use cost of an employee’s personal vehicle after accounting for taxes, business mileage, location, and vehicle expenses. A flat monthly allowance may be simple, but it may not be fair if employees drive different mileage levels, work in different cost regions, or lose a large portion of the payment to taxes.
Rather than choosing one “average” allowance amount for every driver, employers should compare the allowance’s after-tax value against expected business vehicle costs. In many cases, a mileage reimbursement or FAVR program may provide a more accurate and tax-efficient alternative.
How Much Is a Typical Vehicle Allowance?
Many employers pay a flat monthly vehicle allowance, often based on budget, role, competitor practices, or historical precedent. But a typical allowance is not always fair.
A flat amount may look competitive on paper, but the employee’s actual value depends on taxes, mileage, fuel costs, insurance premiums, depreciation, and regional vehicle expenses. If the allowance has not been reviewed recently, it may no longer reflect the real cost of using a personal vehicle for work.
Employers should avoid setting a vehicle allowance based only on a national average. A fair allowance should be tested against the employee’s expected business mileage, location, vehicle-cost assumptions, and after-tax take-home value.
Taxes Can Reduce the Value of a Vehicle Allowance
A flat vehicle allowance is usually taxable when paid as a monthly stipend without accountable plan documentation. That means the employee may lose part of the allowance to federal income tax, payroll tax, and state income tax before the payment can be used for vehicle expenses.
For example, a $600 monthly allowance may not provide $600 of usable vehicle reimbursement. If taxes reduce the payment by 30% to 40%, the employee may only receive about $360 to $420 after taxes.
Employers should evaluate the allowance based on its after-tax value, not only the gross monthly amount.
What Makes a Vehicle Allowance Fair?
A fair vehicle allowance should reflect the employee’s business vehicle expenses after accounting for taxes, mileage, location, and vehicle costs. The goal is not to find one average number for every employee, but to determine whether the allowance reasonably covers the cost of using a personal vehicle for work.
Employers should review the allowance regularly because fuel, insurance, maintenance, depreciation, and tax treatment can change over time.
Or just read on for tips on determining a fair vehicle allowance for your employees, since different organizations will have different vehicle expense needs among their employees. These differences depend on factors such as whether the allowance is taxable, where employees work, and how much and how often they drive for work.
Tip #1: Taxes Affect the Real Value of a Vehicle Allowance
Most vehicle allowances are treated as taxable income by the IRS. Unless an organization uses an IRS-approved accounting procedure to substantiate the business use of the vehicle expenses, that organization should be withholding both income and payroll taxes from the amount.
To determine whether your company vehicle allowance is fair, start with the after-tax amount. Taxes could often eat up 30-40% of the overall amount. That $600/month allowance (which is really only worth $509 in yesterday's dollars) might shrink to as little as $360! (And $360 is only $305 in 2020 dollars.)
One way to reduce tax waste is to move from a taxable allowance to a properly documented reimbursement program. FAVR, or Fixed and Variable Rate reimbursement, may be a strong option because it separates fixed vehicle costs from variable operating costs and can support tax-free reimbursement when IRS requirements are met. This IRS-recommended method, known as FAVR, has been growing in popularity in recent years.
Tip #2: Location-Based Costs Affect Vehicle Allowance Fairness
If an organization is based in one region and all its employees live and work there, then one vehicle allowance amount might be fair to them. However, if the organization has employees working in multiple states or across the country, those employees will be subject to location-based cost differences.
Gas prices and auto insurance premiums vary from city to city and state to state. Other costs, including maintenance costs, taxes, and license and registration fees, also vary.
If an organization operates within a single region, its employees' business vehicle expenses can be calculated based on the prices it pays for such expenses. However, if the organization is widespread, a more varied approach to the vehicle allowance is necessary to deliver a fair amount to everyone. That is another strength of FAVR vehicle allowances—they are calculated based on each employee's zip code.
[Read more: Everything Your Business Needs to Know about FAVR]
Tip #3: Mileage Differences Affect Vehicle Allowance Fairness
Even if two employees are based in the same region, they may incur business vehicle expenses at different rates depending on how much they travel. If one driver covers a larger territory or makes more frequent trips, that driver will accrue much more mileage. This will increase expenses, particularly those related to fuel, wear and tear, and routine maintenance.
Does it seem fair for those two employees to receive the same vehicle allowance amount?
That high-mileage driver will experience a financial pinch if the allowance amount is not calculated with those mileage-based expenses in mind. On the other hand, if the organization pays a fair allowance amount to that high-mileage employee, the low-mileage driver will be paid more than is necessary.
This is why a FAVR vehicle allowance integrates a mileage rate into the monthly allowance amount, helping to ease the differences in costs between drivers who drive different amounts.
Adopting and maintaining a fair vehicle allowance
In summary, a fair vehicle allowance covers the vehicle costs incurred by employees who drive a personal vehicle for work. A fair allowance amount is calculated after taxes—or, even better, is paid tax-free. A fair allowance amount is also calculated based on current vehicle costs in each location where employees work. A fair insurance allowance—the portion accounting for premiums tied to business use—should reflect current local insurance rates. Finally, a fair allowance amount is calculated based on differences in the miles employees drive.
Because of these complicated factors, making a blanket statement that $X is a fair vehicle allowance amount is impossible. A typical car allowance benchmark can help as a rough reference, but it rarely adjusts for taxes, insurance, location, and mileage variability. This is why many organizations partner with vendors to generate fair vehicle allowance rates based on vehicle expense data across different locations. Not sure whether your vehicle allowance is fair, taxable, or accurately covering employee vehicle costs? mBurse can help you compare your current allowance against mileage reimbursement and FAVR options to identify where employees may be overpaid, underpaid, or exposed to unnecessary tax waste.
FAQs About Fair Vehicle Allowances
How much is a fair vehicle allowance?
A fair vehicle allowance should cover the reasonable business-use cost of an employee’s personal vehicle. That means employers should consider taxes, business mileage, fuel, insurance, maintenance, depreciation, registration, and location-based vehicle costs rather than choosing one average monthly amount for every driver.
Is a vehicle allowance taxable?
A flat vehicle allowance is usually taxable when it is paid as a monthly stipend without accountable-plan documentation. If taxes reduce the payment by 30% to 40%, a $600 monthly allowance may provide only about $360 to $420 in usable value to the employee.
What makes a vehicle allowance fair?
A vehicle allowance is fair when it reflects the employee’s actual business driving needs. Employers should review the allowance’s after-tax value, the employee’s business mileage, location-based costs, fuel prices, insurance costs, and whether the allowance keeps pace with current vehicle expenses.
Why can one flat vehicle allowance be unfair?
One flat allowance can be unfair because employees may drive different mileage amounts, work in different cost regions, or pay different insurance, fuel, maintenance, and registration costs. A single monthly amount may overpay some employees and underpay others.
Is FAVR better than a vehicle allowance?
FAVR may be a better option when employees drive different mileage levels or work in different cost regions. Unlike a flat vehicle allowance, FAVR separates fixed costs, such as insurance and depreciation, from variable costs, such as fuel, maintenance, and tires. When IRS requirements are met and business use is properly documented, FAVR can support tax-free reimbursement.
How often should employers review vehicle allowance amounts?
Employers should review vehicle allowance amounts at least annually, and sooner if fuel prices, insurance premiums, mileage patterns, or employee territories change significantly. A fair allowance should reflect current business vehicle costs, not only past budgets or outdated benchmarks.