Ever since Congress passed the tax cuts, we have been highlighting the ways the new tax code interacts with labor codes in employee-friendly states. Today we’ll discuss the best approach to navigating the challenges created for employers in these states.
How tax reform impacted car allowances in states with strict labor laws
Several employee-friendly states (CA, IL, RI, MA, ND, SD) have labor codes that protect employees from business expenses (i.e. employee expense indemnification). Other states are considering strengthening their labor laws to do the same.
The tax reform eliminated the unreimbursed business expense deduction for the tax years 2018 through 2025. Employees will now seek recourse to protect their take-home pay, which could mean turning to state labor codes to recover unreimbursed expenses directly from their employer.
To spell it out more directly, employees who receive a car allowance were accustomed to being able to write off their business mileage every year. Now they can't. For these employees, the tax cuts actually amounted to pay cuts. But if they reside in a state such as California with strict labor laws like CA Labor Code 2802(a), then they have recourse to force their employers to cover any unreimbursed vehicle expenses that the mileage deduction used to cover.
The fact is, with 30 to 40% of a taxable car allowance going to taxes, many employees under that vehicle plan will have a case using state labor laws. This situation leaves U.S. companies more exposed than ever to employee complaints, higher attrition rates, labor code fines, and class action lawsuits.
Ways to keep your car reimbursement labor-code compliant
Prior to tax season, a thorough review of your car allowance or vehicle reimbursement is necessary in order to provide the protection your company needs. Unfortunately, simply increasing your car allowance or mileage rate may prove costlier than doing nothing. Yet doing nothing will leave you exposed to an unacceptable level of risk.
So what are your options, other than continuing to pay a taxable car allowance that likely does not meet employee needs, or increasing company costs by increasing that car allowance?
1. Take the easy route: the IRS mileage rate
A lot of organizations are going to take the simplest, least risky route of all the risky routes: just pay the IRS mileage rate to all employees in the employee-friendly states. This approach, however, is not the best option.
Paying the IRS mileage rate will introduce a new set of challenges while exacerbating existing challenges. First, switching from a car allowance to the IRS rate will prove costly and add the complexity of employee-reported mileage, which makes cost-control a huge challenge.
Second, sticking with the IRS rate if you’re already paying it will likely result in an increase in reported mileage. Employees who are currently being under-reimbursed will find ways to boost their reimbursement, i.e. “driving for dollars.”
Third, the IRS rate is not quantifiable. Sure, you’re paying the maximum allowable non-taxed amount, but how do you know whether the IRS mileage rate is too much, too little, or just right? And what about the significant inequities that exist between low-mileage and high-mileage drivers?
You should be aware that the IRS rate could soon be challenged in California as not complying with CA Labor Code 2802(a) because it’s not quantifiable. The fact is, if you want to truly reduce your risk and treat your employees right, you need to adopt an approach that quantifies employee expenses and bases the reimbursement or allowance on those expenses.
2. Take the better route: Pay a quantifiable vehicle reimbursement.
There are three approaches to quantifiable reimbursement:
- Pay actual vehicle expenses for each employee.
- Pay a standard amount to all employees and then pay additional compensation to cover the expense of a personal vehicle.
- Pay a fixed and variable rate reimbursement (FAVR), an IRS-approved procedure for accurate reimbursement.
The problem with the first approach is that it’s extremely difficult, expensive, and administratively burdensome. The more employees you have, the harder it gets—and no one likes keeping track of receipts.
The second approach is less time-consuming, but it is still administratively complex and leaves open the possibility that you will still under-reimburse some employees and thereby violate a labor code. You constantly have to review employee expenses to make sure you are covering the costs for each employee.
The third approach, FAVR, is administratively complex as well, but it is the best approach. FAVR is considered the gold standard for reimbursement: transparent, based on actual data, and defensible.
How FAVR car allowances work to comply with labor codes
Because a FAVR reimbursement uses vehicle and geographic data to provide quantifiable payments, it fully complies with even the strictest state labor laws.
Operating a FAVR program cost-effectively often requires a third-party partner like mBurse. But the advantage is, you don’t have to devote administrative resources to matching employee expense data with reimbursements.
Instead, this is how the program works:
- You select the appropriate standard vehicle for each employee role that requires reimbursement.
- We generate individualized reimbursement rates based on the standard vehicle and the territory costs of each employee’s garage zip code.
- Using these rates, you provide each employee with a fixed monthly amount to cover fixed expenses plus a variable mileage rate multiplied by employee mileage to cover variable expenses.
If you would like a more in-depth description of how a FAVR plan operates, read our ultimate guide:
A FAVR reimbursement is more accurate than both the IRS mileage rate and a traditional car allowance. The IRS mileage rate is based on an average set of expenses for all American drivers over the previous year. It is not calculated for your individual employees. FAVR, on the other hand, is calculated for your employees. Similarly, a traditional car allowance is a one-size-fits-all approach to employees that incur a variety of expenses. You need an individualized approach, and FAVR is the most cost-effective way to do that.
By switching from a taxable car allowance, you can leverage the eliminated tax waste into an accurate and more robust employee benefit. By switching from the IRS rate, you gain increased cost control. In both cases, you gain an accurate, quantifiable reimbursement and greatly reduce your risk of a labor code violation.
Finding a partner to help with labor code compliance
As the new year approaches, it is imperative that you review your current vehicle reimbursement or car allowance policy and weigh your options.
You can choose to do nothing, which will leave you increasingly exposed as employees discover that they cannot write off unreimbursed expenses and as states consider stricter labor laws to help employees out.
You can choose to pay a higher car allowance amount or higher mileage rate, such as the IRS rate, which will be costly and still will not necessarily protect you from labor code violations because neither is truly quantifiable.
Or you can adopt an accurate and quantifiable reimbursement plan, which in all forms will require significant expenditures of time and resources to keep track of employee expenses and ensure that all expenses are accurately reimbursed. However, this route is cost-effective if you partner with someone who can do the administrative work efficiently.
As you weigh your options, consider partnering with mBurse. Get started by comparing your current plan with an mBurse FAVR plan.