In the post-pandemic, post-tax reform economy, it is more important than ever to offer a flexible car reimbursement. 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
As we established in the 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. This is why an allowance or reimbursement rate that is fair and accurate for everyone needs to start with the business costs employees incur from using their vehicle for work. But costs associated with vehicle choices should not factor into this calculation.
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 – and they should remain free to drive what they wish, as long as it fits the company's mission and the worker's role. But that vehicle choice should not impact their reimbursement rate or car allowance.
By standardizing the vehicle used to generate 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). Also, by starting with a standard vehicle, you eliminate arguments that the reimbursement 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 appropriate to the role.
For a sales rep, that might be a mid-sized sedan such as a 2021 Chevy Malibu or 2021 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 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 if you just find out the national average costs. 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 location-based effects on the vehicle's costs.
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 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.
Auto reimbursement plan implementation
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
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 use the calculator below.