In the wake of the 2018 tax reform businesses MUST fully reimburse employees who use personal vehicles for work. The changes in tax code have eliminated the federal deduction for unreimbursed business expenses until 2025. Employees will look more than ever to employers to fully cover their expenses.
Car allowance and mileage guidelines for 2020
In the past, instead of paying a car allowance, some organizations have told their employees to just write off vehicle expenses. Others have paid a standard company car allowance year after year without checking to see whether employees’ expenses were fully being covered—because they knew employees could just fill out Form 2106 on their tax return and deduct their business mileage or their actual expenses.
But that time has passed. Many employees with business vehicle expenses essentially took a pay cut when they filed their 2018 taxes—unless their employer was already fully reimbursing their expenses. This situation has continued into 2019 and will continue for the next five years.
This means that employers need to follow a stricter set of guidelines when it comes to paying a car allowance or mileage allowance in 2020. Employees who find that their vehicle costs exceed their monthly vehicle reimbursement will complain or take costly measures that could include leaving the company. On our 2019 car allowance survey, over 60% of respondents reported these type of complaints.
Why it’s time to evaluate your car allowance policy
If you own or manage a business that pays a car allowance, you need to take the new tax landscape seriously. You need to re-evaluate the amount you pay employees each month and ensure that no employee faces an income loss via increased taxes. Otherwise, as employees figure out that they’ve lost what amounts to a massive deduction for many of them, they will take measures to recoup that loss. These measures could include the following:
- Labor code complaints and lawsuits – Illinois and California labor laws require full reimbursement of employees; other states have similar laws to protect employee rights, and it’s likely that more states will pass protective measures now that employees can’t deduct business mileage on Form 2106.
- Loss of productivity compared to costs – Employees who receive a flat allowance may drive less to save money, which can cause sales and client relations to suffer.
- Increased attrition – Employees whose companies do not adjust to the new tax code will leave for employers who fully reimburse employee expenses.
Car allowance tax rules for 2020
As you re-evaluate your business vehicle policy, you need to be aware of how different kinds of car allowances are treated under the tax code. Whether your employees' vehicle allowance is taxable can have a big impact on how strongly they feel the new tax law.
Traditional car allowance (taxable)
If you pay a set monthly amount to employees, that allowance or vehicle stipend is considered taxable by the IRS, unless you follow certain procedures to substantiate the business use of payments for vehicle expenses. Because these employees often lose 30 to 40% of their allowance to taxes, they relied heavily on the old mileage deduction to fully offset vehicle expenses.
Mileage allowance (a.k.a. mileage substantiation)
If your employees receive a car allowance but track their mileage in order to substantiate business use, then they likely don't pay taxes on their allowance. However, under IRS rules, to remain non-taxable, this plan must cap payments at the equivalent of the IRS mileage rate for the number of miles the employee drove. While this cap can rein in costs, it can also leave employees exposed to unreimbursed expenses and therefore in need of the lapsed tax deduction.
There are other ways to avoid taxation, such as paying the IRS mileage rate or a fixed and variable rate allowance (FAVR). Any employee facing tax withholding on an allowance or a cap on mileage may face a gap between take-home pay and vehicle expenses and need a change in their car reimbursement for 2020.
Determining the right vehicle reimbursement policy
Different companies have employees with different expense needs. Even within a company expenses can vary greatly. You need a guide to help you figure out the right car reimbursement policies for your organization and its employees.
We have created a detailed exploration of the ins and outs of car allowances to help you navigate the new landscape. In this guide you’ll discover
- The full range of employee expenses an allowance should cover
- The methods companies can use to reimburse employees for business expenses, including monthly stipends, mileage allowances, mileage rates, and fixed and variable rate car allowances (FAVR).
- The best method for your organization’s size
- Whether your vehicle allowance should be taxed
- How the IRS mileage rate works and whether it’s right for your company
- Ways to comply with strict labor laws like California Labor Code Section 2802(a) or the Illinois Wage Payment and Collection Act.
- The shortcomings of both traditional company car allowances and mileage reimbursements
- How to address these shortcomings effectively
- Further in-depth information about tax reform in 2020
With a complete understanding of these topics, you can determine whether your current policy will withstand the new tax landscape. You’ll also be equipped to fit your allowance amount to the actual needs of your employees. This way you can retain good employees while controlling costs.
Take the time to educate yourself now so that you can treat your employees equitably in the coming years. If you would like to take concrete steps right now, take advantage of our new 3-step, self-guided process of developing a competitive, transparent, and cost-effective policy.