A growing number of states have expense indemnification labor codes. If your organization pays a car allowance or vehicle reimbursement, here’s how to ensure your compliance – even in times of high gas prices.
State labor codes and employee reimbursements
Car allowances and mileage reimbursements are straightforward. Your company provides employees with either a preset amount or mileage rate to offset the use of their personal vehicle costs. But that allowance or reimbursement can get pretty complicated if any of your employees operate in states with expense indemnification clauses in their labor code.
These states dictate how, when, and how much employees are reimbursed for the business use of personal equipment such as vehicles. These labor codes cover more than just vehicle reimbursements, including cell phones, internet, data plans, and more. We are going to focus primarily on vehicle reimbursements.
Expense indemnification defined
Expense indemnification codes are wage and payment laws designed to prevent companies from passing on business expenses to employees. To indemnify an employee from business expenses means to protect that employee from having to personally subsidize any company expenses.
California Labor Code 2802(a) best exemplifies expense indemnification. This labor law was established to protect pizza delivery drivers. These employees were being paid low wages and had to operate their personal vehicles. When their costs to operate their vehicles impacted their income, there was a potential lawsuit. Since then, several large organizations in California beyond pizza chains have faced lawsuits and hefty fines for failing to protect their employees’ income from expenses.
States with expense indemnification laws
Nine U.S. jurisdictions currently indemnify employees from company expenses: California, the District of Columbia, Illinois, Iowa, Massachusetts, Montana, New Hampshire, North Dakota, South Dakota. While variations exist between specific state labor codes, all nine jurisdictions require the following:
- Employers cannot pass on their costs to employees.
- Employers must maintain a written policy to describe the reimbursement.
If you currently have employees working in one of those nine jurisdictions, you need to ensure that your vehicle reimbursements fully cover all employees’ expenses and that you have a written policy governing these reimbursements. Be aware of additional employee-friendly states, such as Michigan and New York, where lawsuits have occurred as a result of under-reimbursing employees. Furthermore, both New York and Pennsylvania state laws require employers to follow through with contractually promised reimbursements in a timely manner.
How indemnification labor codes impact your business
No one wants to pay penalties or fines as a result of labor code violations. No one wants to face a class-action lawsuit, either. These worst-case scenarios should impact your choices today regarding your employees who use a vehicle to carry out their job.
The larger the organization, the more expensive labor code violations can get. On average, the penalties can amount to $4000 per employee per year. The employer can also expect to pay for the employee’s legal fees going back up to four years.
While it may prove costly in the short run to ensure full reimbursement of all employee drivers, the long-term cost of penalties, fines, and lawsuits will have a bigger impact if your organization fails to comply with labor laws in the states where your employees work.
High gas prices and expense indemnification
During extended periods of high gas prices, it is particularly important for organizations to make appropriate recalculations of reimbursements. While over time gas prices tend to even out (assuming an appropriate reimbursement rate in the first place), sometimes historically high prices can continue for awhile.
Employees who rely heavily on vehicle travel for their work will experience a shortfall pretty quickly. They may reduce travel, which may reduce productivity. They may bump up the amount of reported miles to compensate for the increased expense. If the situation continues long enough, they may file a complaint if they live in a state that indemnifies employees from business expenses.
These realities make it important to regularly assess and modify the car allowance or reimbursement rate. Otherwise, in times of rapidly increasing inflation and fuel costs, employees will take measures to protect their income on their own – measures that will not likely benefit the company.
Ensuring labor code compliance
Given the expenses that come with labor code violations, and given the current level of inflation and gas prices, it’s important to take steps now to avoid future complications. For an immediate fix, follow these two quick and easy steps:
- Update your vehicle reimbursement policy as soon as possible.
- Change your mileage rate to the IRS mileage rate.
However, these quick fixes are not long-term solutions or best practices and will lead to other problems later. We only recommend these as short-term solutions to “buy you time” to implement a more permanent fix.
The IRS mileage rate has typically been recognized as the standard for compliance with labor codes. However, current circumstances render it a problem for California drivers. Because the rate cannot be substantiated and because of the large variance in costs and territory sizes within the state of California, it can be challenged easily. The cost per mile of a low-mileage driver can easily eclipse the IRS mileage rate. This is because fixed car costs, such as depreciation and insurance, are spread over fewer miles.
The IRS mileage rate was calculated based on last year's average costs and this year's expected costs. California experiences significantly higher costs than average, especially in the area of fuel.
There are better options for a long-term solution. We recommend the Fixed and Variable Rate Reimbursement (FAVR), which is more accurate and substantiable than the IRS mileage rate. FAVR is an IRS accountable plan and the best way to remain compliant with ALL expense indemnification labor codes. All employees receive a fair rate that takes both fixed costs and geographic cost differentials into consideration. The best thing is the rates are driven by data and transparent to employees.
How the tax reform impacts labor codes
Under pressure from the Tax Cut and Jobs Act (2017), employees have an increased need to exercise their expense indemnification rights under state labor codes. This is because that tax reform eliminated a popular deduction for unreimbursed business expenses.
In the past, many employers and mobile employees relied on this deduction to “make them whole” at the end of the year. But now that is not possible for tax years 2018-2025. Because taxpayers may no longer deduct business mileage, employees increasingly expect full reimbursement of expenses. In 2019, Illinois changed its law to better protect employees' income. Other new states may soon also indemnify employees from company expenses.
Given the current tax landscape and soaring inflation (especially gas prices), it is very important to properly reimburse employees for the business use of their personal vehicles. In the event that employees in employee friendly states are not reimbursed properly, your organization could face an increase in expense indemnification violations.
Contact mBurse to learn more about how switching to a FAVR reimbursement plan could help your organization comply with labor codes—and save money in the process.