Calculating a fair vehicle reimbursement amount is not as simple as multiplying a mileage rate by miles driven. This is because paying an equal rate to employees is not equitable.
The short answer: a fair vehicle reimbursement is equal to the total reasonable expenses associated with the use of a personal vehicle on behalf of an employer.
But how do you calculate the total amount of reasonable expenses?
Many organizations opt for a catch-all mileage rate such as the IRS business mileage rate. This approach has the advantage of ease and convenience. The problem is, paying an equal rate to all employees practically guarantees that the reimbursement amount will overpay or underpay some employees.
Two considerations that a fair vehicle reimbursement must take into account are geographical cost differences and differing rates of accruing expenses. Here's a look at each one with tips for how to develop a rate that fairly addresses each.
If your organization employs workers in different parts of the country, then geographical cost differences will lead to expense differences for employees, even if they drive the same car and the same number of miles.
The easiest way to see how geographical cost differences work is to look at gas prices. The gas prices map published daily by AAA is a helpful tool. The national average for gas prices as of January 15, 2024, is $3.068 per gallon. Here are three states for comparison:
In terms of fuel costs, it is more expensive per mile to operate a vehicle in California than in almost any other state. But even within a state the costs can vary. A driver in north Texas might pay $2.50/gal or less while a driver in west Texas will likely pay more than $3/gal right now.
Every year Forbes Advisor publishes a list of the average costs for full auto insurance coverage in each state. While the national average is $2,118 per year, there is actually quite a wide range between different states:
A large company with employees working in both New York and Ohio will see huge discrepancies in their insurance costs. But even a smaller, more regional company could see significant discrepancies. With New York more than twice as expensive as neighboring New Jersey, an equal reimbursement rate could be unfair to those employees.
Other location-sensitive vehicle costs can include personal property taxes, license, registration, and maintenance. Not all states have personal property taxes that include personal vehicles. And the fees associated with vehicle ownership can vary widely by state, though these are usually only a small portion of overall vehicle expenses.
Maintenance costs tend to be higher in places where the cost of living is higher, especially in urban areas where rents are higher. Recent increases in the costs of vehicle maintenance and repair, however, have been affected by supply chain issues that have caused parts prices to rise everywhere.
Depreciation, which is also a reimbursable expense (the business use portion), is less sensitive to geography, but it is a cost that must be taken into account when an employee is operating and maintaining a personal vehicle for work done at the behest of the employer.
The easiest way to provide a fair reimbursement to employees working in different locations is to purchase location-sensitive expense data. You will also increase fairness if you calculate vehicle costs using a standard vehicle suitable for the job, say a mid-size sedan or crossover SUV.
Businesses that want to reimburse vehicle use fairly have two options:
The latter option may be the most cost-effective unless your organization has people in the HR Department with the skills to efficiently generate fair vehicle reimbursement rates with appropriate software.
Different drivers accumulate vehicle expenses at different rates. This is not just because some live and work in more expensive areas than others. Expense accumulation varies in direct proportion to mileage accumulation. The key concept to remember is that, while the amount of expenses increases with the miles driven, the rate of expenses decreases.
The more a person drives, the less expensive it is per mile. This is because many vehicle expenses are a given no matter whether you drive a lot or a little. These fixed expenses are what can cause a low-mileage driver to be under-reimbursed in a typical mileage reimbursement program.
All workers who use a vehicle for their job begin with a certain set of fixed costs. These include insurance premiums and all taxes and fees levied by their state and/or locality. Depreciation is mostly a given, since it is more driven by the age of the vehicle than the mileage on the vehicle.
The more miles you drive, the sooner you recover these fixed costs under a mileage reimbursement program. A fair vehicle reimbursement must ensure that the reimbursement rate not only covers these costs but also the mileage-based costs on top (fuel, oil, tires, maintenance).
Because of the given, fixed vehicle costs, every driver has a number of miles driven where their reimbursement amount exactly matches their expenses. Beyond this amount, their expense accumulation rate decreases below their reimbursement rate. They begin to make money at this point.
Let's say you have two employees who are based in the same zip code and you calculate their rates using the same standard vehicle. If one drives 10,000 miles annually and the other drives 20,000 miles annually and they are reimbursed at the same cents-per-mile rate, you will have an inequitable reimbursement. Here's an illustration using the 2024 IRS mileage rate of 67 cents per mile:
A fair vehicle reimbursement must take into account these different rates of expense accumulation. The same vehicle operated in the same location will need a different reimbursement rate if driven substantially different amounts. To determine a fair reimbursement, you must determine the range of mileage amounts among employees.
If your mobile employees drive within a fairly narrow range annually, then you may be able to pay the same rate to everyone, adjusted only by location cost differences. But if you have a wide range of mileage amounts, it will be impossible to reimburse all employees fairly with one rate. Some organizations try to address this by paying for fuel separately from other expenses, since it is the most variable by location and most sensitive to miles driven. But that will not resolve the fundamental problems.
Two options to consider:
For help with the expense data needed to develop a more optimized rate, explore mBurse Professional Services. Or learn more about partnering with mBurse for FAVR plan administration.