Mileage reimbursements face scrutiny when employees discover that their rate isn’t covering their costs, even if you are using the IRS mileage rate. How will you answer when an employee asks you to explain your company’s mileage rate?
When employees question your mileage rate...
In the past, when an employee realized that their mileage reimbursement wasn’t covering all their vehicle costs, they could just write off the gap at tax time. But the 2017 tax reform eliminated the business expense deduction until 2026. Employees are more likely than ever to raise concerns if their mileage reimbursement isn't covering costs – especially since the Covid-19 pandemic has caused reduction in business mileage for many people.
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 mileage rate cover?
A: It covers employees’ vehicle costs.
Q: How do you know that it covers everyone’s costs?
A: It’s the IRS mileage rate.
Right there we run into a common misconception: that the IRS business mileage rate sufficiently reimburses all employees. The truth is, sometimes it does, often it doesn't.
The IRS mileage rate explained
IRS standard business mileage rate was developed to capture the average costs of vehicle ownership across the country for the purposes of tax deductions (the rate for 2021 is 56 cents-per-mile). But if you have employees working in multiple regions across the country, they do not all experience the same vehicle costs – California is a lot more expensive than Alabama.
In that case it’s just not possible to conclude that your mileage reimbursement covers all employees’ vehicle costs.
There’s another problem with mileage rates: they tend to under-reimburse low-mileage drivers. Fixed costs like depreciation and insurance make up around 60% or more of the cost of vehicle ownership for the average person. The less you drive, the larger the percentage of these fixed costs, and the less adequate a payment is that’s tied directly to mileage.
So whether you’re paying the IRS rate or another mileage rate, chances are that some of your employees are feeling pinched. (And chances are that your high-mileage employees are over-reimbursed, but that’s for another blog post.)
What’s your vehicle reimbursement rate based on?
When companies adopt a mileage rate, they do it for the ease of use. If they go with the IRS-issued rate, it’s probably because so many companies now see this as the “gold standard” for vehicle reimbursement. The problem is, they don’t ever think about what this rate is actually based on and whether it works for all employees.
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 reimbursement amount. And even the IRS rate is being challenged in some places.
Here are the questions you need to answer before setting your mileage rate:
- What is my vehicle reimbursement rate based on?
- When was the last time I adjusted this rate?
- Do any of my employees incur expenses greater than the reimbursement?
- How can I quantify the reimbursement to protect the company from labor code violations and lawsuits?
Based on your answers to these questions, use the following guide to come up with a fair mileage reimbursement plan.
How to immediately improve your vehicle reimbursement policy
Base your reimbursement rate on data.
If your mileage reimbursement is based on 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. Remember, the IRS rate is based on last year’s averages, not on your employees’ data. You need to know the range of expense needs within the company—between your drivers working small or inexpensive territories and your drivers working large or costly territories.
Use a reimbursement rate that works for all employees.
If you’ve been using the same mileage rate for a long time, 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 unreimbursed expenses. If not, many of them will likely begin driving extra, unproductive miles or even report extra miles that they didn’t drive.
Don't pay an equal amount for unequal expenses.
If you find that employees drive widely varying distances or face discrepancies in geographic costs, then one single mileage rate just won’t work for everyone. Unless the range of expenses between employees is fairly narrow, you will need a more flexible approach than a standard mileage rate.
Quantify the reimbursement rate, protect the company.
Once you have the data on your employees’ vehicle expenses, and have adjusted your vehicle reimbursement policy to cover all employees’ expenses, you should be able to quantify how the reimbursement covers these expenses. That will protect your organization from labor code violations.
But all this requires a greater level of flexibility than the typical mileage rate can deliver – especially if you have both high-mileage and low-mileage drivers.
An alternative: FAVR mileage reimbursement
By far the best way to accomplish all four of these goals in a single plan is to adopt a fixed and variable rate reimbursement, or FAVR. Unlike a traditional mileage rate, this plan pays an individualized reimbursement to each employee.
A FAVR vehicle program solves the cost discrepancies between varying mileage amounts by adding in a fixed payment to address fixed expenses like insurance, depreciation, and registration. The mileage rate is a variable payment that fluctuates with operational costs like fuel, tires, and maintenance. Hence the name “fixed and variable rate.”
A FAVR vehicle program also solves the cost discrepancies between geographic regions. Both the fixed payment and the variable reimbursement rate are derived from cost data specific to the employee’s garage zip code. Because the payments are based on data, everyone gets reimbursed accurately in a way that’s quantifiable. You are thereby able to protect the company from labor code violations.