If you can’t quantify what your car allowance covers, you could be in trouble. Vehicle costs have risen significantly, and employees no longer have the ability to deduct business mileage on their taxes.
Employee car allowances - How much is enough?
For years, employees who received a car allowance enjoyed a sizable tax deduction for business mileage. In the absence of this tax write-off until 2026, it is more important than ever for employers to demonstrate that their company car allowance can meet employees' needs.
With gas prices and vehicle prices skyrocketing, and the pandemic placing pressure on organizations to provide robust employee benefits, every employer should be able to explain how they derive their company car allowance amount.
Here's a typical exchange we have with clients that shows the importance of quantifying a car allowance:
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 is 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 is your 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. This approach is familiar and easy, but without quantifying the allowance, they cannot prove that it covers employee expenses.
This is a problem. Several states have laws that require full reimbursement of business expenses. 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 that amount?
- What is my risk of labor code violations and lawsuits?
- How much is my car allowance taxed?
Based on your answers to these questions, use the following guide to quantify employee vehicle expenses and calculate a car allowance amount.
Calculating a car allowance for 2022 and beyond
1. Base the allowance amount on vehicle expense data.
If your auto allowance amount is derived from anything other than vehicle 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 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. Calculate an allowance that covers all employees' vehicle expenses.
If it has been several years since you’ve increased your car allowance amount, chances are that it’s not serving the needs of your employees. Treating employees fairly will likely mean boosting the allowance.
This is 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 for unequal expenses.
If 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 boost everyone’s monthly payment to the level of the drivers who face the highest costs. Unless the range of expense amounts between employees is narrow, you will need a more flexible approach than a standard car allowance or mileage rate.
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. But quantifying the allowance may require paying more than one car allowance amount.
4. Switch to a non-taxable car allowance such as FAVR.
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 30 and 40 percent in taxes. You can take those tax dollars and redirect them into a new plan that increases employees take-home pay without adding to the bottom line.
How a FAVR car allowance works
By far the best way to pay a quantifiable car allowance that will stay affordable is to adopt a fixed and variable rate allowance, or FAVR reimbursement plan. Unlike a traditional, taxable allowance, this plan pays a pinpoint vehicle reimbursement to each employee, keeping the payments tax-free.
Rather than paying a standard rate, a FAVR vehicle program starts with a standard vehicle appropriate for the job and applies geographically-sensitive expense data for that employer-selected vehicle to calculate defensible rates for all employees.
Because FAVR is a tax-free reimbursement, employees get to keep every penny they are paid. Because the payments are based on data, everyone gets reimbursed accurately. 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.