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 reimbursement?
A fair vehicle reimbursement 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.
To protect your organization from complaints by employees and violations of federal or state regulations, you need to pay attention to rules and guidelines set forth by the IRS and state labor codes. 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).
Labor laws can be more demanding 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.
Fair and equitable auto reimbursement methods
There are a number of ways you can "make employees whole," but each method's fairness will depend on your organization's situation.
- 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.
- A mileage reimbursement pays a set mileage rate to all employees. The most common rate is the IRS standard business rate. (65.5 cents-per-mile for 2023.) Any rate equal to or less than the IRS rate is tax-free. An IRS-compliant mileage log is required to substantiate business use.
- 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.
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.
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.
Vehicle reimbursements and IRS compliance
Taxation is the biggest threat to fairness when it comes to car allowances. Because around 40% of a car allowance amount can go to taxes, any organization that uses a non-accountable plan will likely shortchange some employees.
A $600/month allowance becomes a $360/month payment due to tax withholding. In today's inflationary economy, that $360/month will almost certainly not be enough to cover auto insurance, gas, maintenance, and other reimbursable costs such as depreciation.
Implementing a tax-free reimbursement policy is important if you want to deliver fair payments to offset the use of a personal vehicle. Valuable employees who receive a taxable allowance may eventually leave for an employer with a more competitive program – one that delivers tax-free payments that protect the employee's income from incurring costs that truly belong to the employer.
When it comes to delivering a non-taxable plan like a mileage rate or a FAVR allowance, the key is to adopt an automated mileage tracking system. A mobile app that tracks mileage during business trips can automate the process, making the task of substantiating business use convenient for employees while keeping your organization compliant with the IRS. It is vital, however, that you choose a mileage app that prioritizes employee privacy.
Crafting a labor code compliant business auto policy
At least nine different jurisdictions in the United States have labor codes that indemnify employees from incurring businesses expenses that belong to their employer. In California the relevant labor law is Section 2802(a). In Illinois, the relevant code is found in the Wage Payment and Collection Act.
Both of these labor codes require employers to fully reimburse all reasonable expenses related to carrying out job responsibilities. This includes vehicle ownership and operating costs. A number of other states, including New York, Massachusetts, Rhode Island, and the Dakotas, have similar employee-friendly laws that protect employees from having to pay for business costs.
Because car allowances can leave employees short after taxes, they are not ideal for businesses that operate in states with employee indemnification labor codes. But even the IRS mileage rate can fall short in an expensive place like California, especially for employees who do not drive a ton.
The only way to ensure that your organization is protected from labor code violations is to use a vehicle reimbursement that is based on vehicle expense data specific enough to cover your employees' situations.
Implementing a fairer reimbursement 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.