Every HR leader wants to ensure that employees are treated with fairness in compliance with applicable laws. When it comes to vehicle reimbursements, a fair, compliant policy can go a long way to making employees feel valued.

What is a fair, compliant vehicle program?

A fair business vehicle policy requires more than just a standard monthly car allowance or standard mileage reimbursement rate. This is because expenses for employees can accrue at different rates depending on where they live and how much they drive. For this reason, a fair vehicle reimbursement policy must be equitable rather than equal.

But there are a number of challenges related to compliance with various rules and guidelines set forth by governing authorities. In some cases, focusing on compliance will also contribute to making your program more fair and equitable. In other cases, it can add to the challenge.

Compliance with IRS rules for business vehicles

Compliance with the IRS means that you collect taxes on a non-accountable plan and that you follow appropriate procedures to substantiate business use on an accountable plan (i.e. non-taxable). What's the difference?

An accountable plan is tax-exempt because the employer follows a set of accounting procedures to prove business use of the vehicle in relation to all payments. This can include tracking or logging mileage, including dates, destinations, and purposes of trips. It also means following guidelines about maximum payments, such as the IRS business mileage rate or the IRS maximum value of a FAVR vehicle plan or a company vehicle. 

Failure to withhold taxes on a non-accountable plan is a serious problem. But even if you follow all the rules and withhold taxes properly from taxable payments like a standard car allowance, you can perpetuate inequalities resulting from insufficient after-tax amounts. 

Personal use chargebacks on fuel or company vehicle 

Not everyone realizes that a company-issued fuel card is taxable unless a method is used to substantiate business use of the fuel. A mileage tracker or log is the typical way to do so. Any personal use of fuel should be charged back to the employee or treated as taxable income.

The same is true for personal use of a company-issued vehicle. If the organization does not require employees to distinguish between business and personal mileage, then the equivalent value of the vehicle for that personal use would be considered taxable. This is why, if your organization pays for fuel and/or issues a company car, it is important to also operate a personal use chargeback policy.

Labor laws and business use of personal vehicles

Labor laws can be even more demanding than IRS rules because they are designed to ensure fair, equitable reimbursements to employees. The key is to know which jurisdictions have employee-friendly laws that govern car allowances and reimbursements, and whether you have or will have employees in one of those jurisdictions.

The most stringent labor laws are found in California, Illinois, and Massachusetts. These states require the full reimbursement of all reasonable costs associated with the use of a personal vehicle for work. The company cannot pass on any business costs. In these states, employers must be able to prove that their vehicle policy fully covers all employee vehicle costs associated with their work.

Some other states also have strict laws that govern the use of a personal vehicle on behalf of an employer or laws that govern how and when reimbursements should be made for vehicle use. To learn more, read our post on compliance with employee indemnification codes and our guide to vehicle reimbursement laws in New England.

Fair and compliant auto reimbursement methods

There are a number of ways you can compensate employees for vehicle use, but each method's fairness will depend on your organization's situation. Similarly, compliance will depend on where the organization operates, since different states have different labor laws.

• A standard monthly car allowance pays one standard amount to all employees. This payment is treated by the IRS as taxable compensation. Employees pay income taxes on the amount, and the employer and employee together pay FICA/Medicare taxes as well. Employers can add mileage substantiation to make this an accountable plan. This rate does not guarantee compliance with state labor laws.
• A mileage reimbursement pays a set mileage rate to all employees. The most common rate is the IRS standard business rate. (67 cents-per-mile for 2024.) Any rate equal to or less than the IRS rate is tax-free. An IRS-compliant mileage log is required to substantiate business use. Mileage reimbursement at the IRS rate is typically seen as compliant with state labor laws.
• A fixed and variable rate allowance (aka FAVR) pays a combination of a set monthly allowance and a mileage rate that adjusts as prices rise and fall. This IRS-approved reimbursement procedure bases all rates on a standard vehicle and what it would cost to own and operate that vehicle within each employee's zip code. This rate is consistently compliant with state labor laws.

The first two methods are most fair when you have a small number of employees that drive similar amounts each month and live in the same region. Both car allowances and mileage reimbursements, however, can create inequities between employees who work in locations with widely varying costs or who drive widely varying amounts.

The taxes on a standard car allowance can reduce take-home pay well below a fair rate. Because taxes may eat up 40% or more of the allowance amount, the take-home amount may be well below the amount required for full reimbursement. This would violate some state labor laws and may contribute to employee turnover.

FAVR policies are designed with equitable reimbursement as the top priority. By generating rates using localized cost data applied to a standard vehicle and by separating out fixed costs from variable costs, a FAVR policy can guarantee that each employee receives payments commensurate with their business-related vehicle expenses. This means that FAVR car allowances also ensure compliance with labor laws. 

Adopting a fair, compliant business vehicle policy 

When it comes to implementing a new policy, so much depends upon clear communication. This starts with written policies governing how reimbursements will be generated and paid to employees, what kind of vehicles they can drive, how much insurance coverage they need, and what tool they will use to track and report business mileage.

But you can have extremely clear written policies that cover everything and still roll out the new policies in a way that inspires distrust and ill will. Transparency is key here. Your employees need to see that these changes are driven by a concern for fairness to them and a desire to ensure long-term that employees will be free to do their jobs without worrying about whether their vehicle reimbursement will cover their costs.

Switching from a taxable to a non-taxable plan is often an easy sell because most employees will see a net gain in their allowance. Assuming you pick an automated mileage app that is easy to use, not glitchy, and protects privacy, you can avoid leaving employees with the feeling that they are being given additional administrative responsibilities that will take up a lot of time.

To get professional advice about how to craft an equitable, compliant policy and implement it smoothly, contact mBurse today.