How to Properly Reimburse Employees Using a Standard Vehicle

Written by mBurse Team Member   |   Jul 31, 2023 12:15:32 PM

With so much of today's workforce gone mobile, a responsive business vehicle program is a must. The secret is to start with a standardized vehicle, not a standardized rate. This guide explains how.

Why a standard vehicle is necessary for fair reimbursements

If an organization has workers who drive as part of their jobs, they may elect to have those workers use their own personal vehicles. The most common programs to manage those personal vehicles are car allowances and cents-per-mile reimbursements. 

As established in a previous post, paying an equal car allowance or mileage rate to employees is unfair because different employees incur vehicle costs at different rates based on location and miles driven. A fair vehicle reimbursement has to be calculated with those variations in mind. However, costs associated with vehicle choices should not factor into this calculation.

How much is a fair car allowance? Find out now.

Workers pick their vehicles for a myriad of reasons – the thrill of a sports car, the utility of a full-size pickup, the environmental impact of a hybrid. That choice affects the cost of operating the vehicle due to differences in fuel costs, tire costs, and more.

By standardizing the vehicle used to calculate company reimbursements, the organization starts everyone on an equal footing before considering the expense needs specific to each person's role (i.e. territory-based costs and mileage-based costs). This approach also eliminate arguments that the rate or allowance is not enough, since these often come from employees who drive expensive vehicles.

How to base a reimbursement on a standard vehicle

When using a standard vehicle, all reimbursement amounts will be based on the cost of acquiring and operating that specific vehicle in the specific geographic area where each driver is located. To build an auto reimbursement plan based on a standard vehicle, you'll need to follow certain steps.

1. Select a specific vehicle that fits each employee's role.

For a sales rep, that might be a mid-sized sedan such as a 2023 Chevy Malibu or 2023 Nissan Altima. For someone who needs to transport people comfortably, it might be a minivan or SUV. It all depends on the requirements of the job. If there are multiple roles within the organization that require a vehicle reimbursement, you may have to select more than one standard vehicle.

Remember, though, that employees will still drive the vehicle they choose, as long as it fits within the company's rules. A person who wants to drive the full-size pickup he uses to pull his fishing boat on the weekends can still drive that pickup; the extra gas expense over the standard vehicle just won't be subsidized by the company.

2. Obtain accurate expense data for the standard vehicle.

Find out what it typically costs to own and operate that particular vehicle. It is important to break down costs into two categories: fixed and variable. The fixed costs – insurance, depreciation, registration and fees, taxes – are relatively easy to come by. The variable costs – gas, oil, tires, maintenance – take more calculating.

If most of the employees are working within the same region, you can actually just focus on the costs of owning and operating that vehicle for that region. But if employees live and work in a variety of locations, then the next step is going to be very important.

3. Determine the localized costs of the standard vehicle.

For each region in which employees operate, you'll need to calculate the increase or decrease in costs compared to the average. This is particularly important for insurance rates and gas prices, which can vary widely by region. (Just compare the average annual auto insurance premium in Michigan, $3,141, vs. Ohio, $1,191.)

These first three components – standardizing the vehicle, separating fixed from variable costs, and determining geographical costs – are the key ingredients to delivering an accurate, equitable, and transparent reimbursement to each employee. These three steps together correct the flaws of standard plans like equal car allowances and mileage rates.

4. Calculate the appropriate vehicle reimbursement rates.

First, calculate the fixed annual costs for the standard vehicle garaged in the employee's zip code driven at the expected number of miles they drive. Add up the annual estimated fixed costs, divide by 12 and then multiply by the percentage of time appropriately considered business use (often this is .71 or 5/7, assuming a five-day workweek). That's the monthly fixed amount an employee should receive.

For variable costs, develop a mileage rate appropriate for each employee. The simplest way is to add up the annual value of those variable costs for the standard vehicle in each employee's location driven at a certain expected number of business miles. Then divide that number by those miles. For example, an expected annual cost of $5,000 for gas, oil, tires, and maintenance, spread out over 15,000 miles would yield a rate of $.33/mile.

How to implement a fair vehicle reimbursement 

Once you know what the monthly fixed allowance and the mileage rate for each employee should be, it is simply a matter of tracking their business mileage and paying a monthly amount that equals fixed allowance + (mileage rate x business mileage). Management reviews the fixed allowance amount every year and the mileage rate every few months and makes adjustments.

There are a number of challenges to implementing and administering this type of plan, which the IRS refers to as a fixed and variable rate car allowance, also known as FAVR reimbursement. These challenges include

  • Obtaining cost data for the standard vehicle in each geographic area
  • Choosing an accurate mileage tracker (we recommend a GPS app like mLog)
  • Developing policies that comply with IRS rules and state labor codes
  • Explaining the program changes to employees
  • Administering a program that is more complex than a traditional car allowance or mileage reimbursement

Transitioning to a new vehicle reimbursement

The new program will be worth these challenges in the accuracy, fairness, and transparency of the new reimbursements. If you currently pay a standard car allowance, the savings of switching from a taxable to a non-taxable plan will be well worth it. If you currently pay the IRS mileage rate, the elimination of costly over-reimbursements and labor-code-violating under-reimbursements will be worth it.

But you may find that these challenges exceed your organization's available resources. mBurse can supply the data you need. We can also help you calculate your rates and write your new policies. We can even administer your program for you. Schedule an exploratory call today or get a cost comparison below.

Compare your vehicle program to a FAVR Plan

Subscribe by email to
receive updates