Paying a car allowance with mileage substantiation? The time is now to re-evaluate your policy as a result of the new tax code.
In the past, implementing a mileage substantiation as a company car reimbursement program made good business sense, unless you had employees working in a state that indemnifies employees from company expenses, such as Massachusetts or California. Mileage substantiation protects both employee and employer from taxation of the car allowance, saving money for both. But changes in the tax code could leave your organization at risk in any state if you do not properly address your car reimbursement policy to complement the new tax code.
Here’s how a typical mileage substantiation program works: You provide a set car allowance for employees that drive for work, say $500/month. Employees then record their mileage, which is multiplied by the current IRS mileage rate—$.545/mile—and subtracted from the car allowance. If the product of mileage times the IRS rate exceeds $500, the employee is still only reimbursed the $500 amount. Many companies that provide a car reimbursement or allowance take the position that employees can write off the difference at tax time.
But that assumption—that employees can write off the unreimbursed amount—no longer holds true under the new code. With the elimination of the unreimbursed expense deduction, employers paying a car allowance with mileage reimbursement can no longer rely on this tax mechanism to make an employee’s compensation for work expenses complete. This will create problems for higher mileage employees.
Case Study: 3 employees, 3 outcomes
Comparing three employees driving three different mileage amounts will show just how big a problem the new tax law will create for an employee who drives a lot.
Mobile Employee A:
Drives 917.5 miles for the month
917.5 miles x $.545 = $500.00
Mobile Employee B:
Drives 1,500 miles
1,500 miles x $.545 = $817.50
Mobile Employee C:
Drives 417 miles
417 miles x $.545 = $227.27
All three employees receive a non-taxed benefit, which is great, but now that, under the new tax code, Mobile Employee C cannot deduct the additional costs of owning and operating their personal vehicle, the company has placed that employee in an unfair situation. If that employee works in a state with an employee expense indemnification clause, they certainly have grounds to file a complaint with the state labor board. Companies operating in California could be especially hard hit if employees gather to file class action suits under California Labor Code 2802(a). Of course, some employees may just look for new jobs.
But this isn’t the only problem that could result from the new tax law.
Are you capping costs or capping productivity?
One of the great advantages of mileage substantiation (beyond avoiding taxation) is the ability to cap reimbursement costs and budget your costs. During the Great Recession, quite a few companies reduced their expenses by transitioning from paying either a taxable car allowance or the IRS mileage rate to paying a car allowance with mileage substantiation. By capping your costs, you are guaranteed not to let the monthly car allowance exceed budget.
But now that employees who exceed the amount capped by the combination of the IRS rate and the monthly allowance cannot write off additional mileage, you may be capping not costs but miles and therefore productivity. Paying a $500 monthly allowance under the current IRS rate of $.545/mile means that any mile driven under 917.5 miles will go unreimbursed.
The problems with continuing to provide this type of policy are simple: Employees will figure out how to leverage the cap each month no matter if they are in high cost areas or have a large driving territory. Some may drive more than necessary to get to the cap. Others who typically drive more may resort to driving up to the cap and not driving until the following month. This will almost certainly result in productivity losses.
It’s time to re-evaluate your mileage reimbursement program
The new tax code eliminates the ability of employees to write off additional business travel expenses. This will most seriously affect companies operating in states with indemnification codes, exposing them to the risk of labor code violations and law suits. But it will affect all companies to the degree that the car allowance caps miles and productivity now that employees cannot write off additional expenses. For at least the next 7 years—when the tax cuts expire—your employees will be looking to find ways to offset the loss of the unreimbursed expense deduction. If their costs are not being met, don’t be surprised if you see a dip in productivity and/or an increase in your attrition rate.
Now is the time to re-evaluate your policy. A great alternative that will keep your reimbursement non-taxable while fully reimbursing employees would be the Fixed-and-Variable-Rate reimbursement, or FAVR. This IRS accountable plan perfectly complements the new tax code. Download our FAVR data sheet to learn more about this highly effective business reimbursement tool.