Last week, we discussed the challenges with the tax reform and labor codes in employee-friendly states. Today we’ll discuss the best approach to working through these challenges.
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 has eliminated the unreimbursed business expense deduction for 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.
This situation leaves U.S. companies more exposed than ever to employee complaints, higher attrition rates, labor code fines, and class action lawsuits.
With tax season looming, a thorough review of your car allowance or vehicle reimbursement is necessary in order to provide the protection your company needs. As we concluded in the last post, 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.
Taking 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. It is important to reiterate, however, that this approach 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?
And as we said in the previous post, 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.
Three approaches to quantifiable reimbursement
- Pay actual 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 works
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, check out our FAVR Q & A.)
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.
Conclusion: You need a partner
As the year 2019 approaches, it is imperative that you review your current vehicle reimbursement or allowance policy and then 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.