If you can’t articulate what your car allowance covers, you could be in trouble. A popular tax write-off is gone for the next six years—the business expense deduction. Unable to deduct mileage, employees will start asking questions about their allowance. How will you answer?
Employee car allowances - How much is enough?
For many years now, employees who receive a car allowance have enjoyed a sizable tax deduction for business mileage. Now that it’s gone, they will focus more than ever on the adequacy of their car allowance. They want to ensure the amount will cover their costs.
In order to prepare yourself for a potential Q & A with a concerned employee, let’s run through a typical exchange we have with potential clients.
Q: What does your car allowance amount cover?
A: Our policy is used to cover employees’ costs.
Q: How do you know that it covers everyone’s costs?
A: Not sure.
Q: Are your employees located in just one geographic region?
A: No. We operate in several states throughout the country.
Q: Do you pay the same car allowance amount to all employees?
Q: How is this fair?
If your company operates in multiple states yet you pay the same allowance amount to all employees, you cannot say confidently that your policy covers your employees’ costs. It’s just not possible. Different locations involve different levels of expense.
You are paying an equal amount for an unequal expense. How can this be a fair car allowance amount for every employee?
What was your 2019 employee car allowance based on?
Many organizations adopt a car allowance that was used at a former company or one that a competitor uses. Often they continue using the same amount they have used for the past 15 years. They do this because it is familiar and easy. But they cannot explain what it’s based on or explain how they know it covers employee expenses.
This is a problem. Because some states have laws that require the proper reimbursement, keeping a familiar or easy policy can get you in trouble. In states like California and now Illinois you have to quantify or substantiate your allowance amount.
To help give you clarity with your vehicle reimbursement policy, we have prepared another set of questions to ask yourself:
- What is my car allowance amount based on?
- When was the last time I adjusted this amount?
- Do any of my employees incur expenses greater than the amount?
- How can I quantify the allowance to protect the company from labor code violations and lawsuits?
- How much is my car allowance taxed?
Based on your answers to these questions, use the following guide to come up with a fair car allowance amount.
How to pay a fair car allowance to employees in 2019, 2020 and beyond
1. Base the allowance amount on vehicle expense data.
If your auto allowance amount is defined by anything other than employee expense data, then chances are your policy is not meeting the needs of employees. The only question is how many employees are experiencing a shortfall.
Don’t forget that the elimination of the business mileage deduction for employees places new pressure on the company to fully cover these expenses. What you need is a sense of the range of expense needs within the company—between your drivers working small or inexpensive territories and your drivers working large or costly territories.
2. Adjust to an allowance amount that covers all employees' vehicle expenses.
If it’s been several years since you’ve increased your car allowance amount, chances are that it’s not serving the needs of your employees. And they will be more eager than ever for an increase to offset the loss of their tax deduction for business mileage. Treating employees fairly will likely mean boosting the allowance.
This will be especially crucial in states with employee indemnification codes, such as California's Labor Code 2802(a), or other employee-friendly reimbursement rules. This growing list includes not only California and Illinois, but also Rhode Island, Massachusetts, the Dakotas, and at least three other states.
3. Don't pay an equal allowance amount for unequal expense amounts.
If you discover that your employees face a wide range of vehicle costs, then a fair car allowance amount won’t be the same for everyone. In fact, it might be cost-prohibitive to simply boost everyone’s monthly payment to the level of the drivers with the greatest expenses. Unless the range of expenses between employees is fairly narrow, you will need a more flexible approach than a standard car allowance or a standard mileage rate.
4. Protect the company by quantifying the new 2019/2020 car allowance amount.
Once you have the data on your employees’ vehicle expenses, and have adjusted your policy to cover all employees’ expenses, you should be able to quantify how the car allowance covers these expenses. That will protect your organization from labor code violations.
5. Switch to a non-taxable vehicle reimbursement such as a FAVR car allowance.
If the steps listed above sound expensive, don’t worry. There’s an easy way to offset any increases in employee car allowances—go tax-free! With a standard vehicle allowance, most employees pay somewhere between 20 and 40 percent in taxes. You can leverage that portion into a new plan that increases their take-home pay without adding to the bottom line.
How a FAVR car allowance works
By far the best way to accomplish all five of these steps in a single plan is to adopt a fixed and variable rate reimbursement, or FAVR reimbursement plan. Unlike a traditional, taxable allowance, this plan pays a pinpoint vehicle reimbursement to each employee, keeping the payments tax-free.
A FAVR vehicle program uses geographic expense data for fixed expenses like insurance, depreciation, and registration to set an employee’s monthly fixed allowance. This plan then adds a variable payment that fluctuates with operational costs like fuel, tires, and maintenance. Hence the name “fixed and variable rate.”
Because FAVR is a tax-free reimbursement, employees get to keep every penny they are paid, resolving the pressure from the tax reform. Because the payments are based on data, everyone gets reimbursed accurately, resolving the unfairness of a standard “one size fits all” payment. The use of data also allows you to quantify the amount, protecting the company from state labor laws.
When we tell our potential clients about fixed and variable rate allowances, they often think it’s too good to be true. But it’s for real—contact mBurse today to learn more.