2021 Car Allowance Policy: How to Determine the Right Amount

Written by mBurse Team Member Nov 23, 2020 7:00:00 AM

The year 2020 brought the COVID-19 pandemic and lots of economic disruption. As we head into 2021 opportunities abound to provide a more competitive car allowance, providing stability in the midst of uncertainty. Employees will look more than ever to employers to fully cover their expenses.

Car allowance and mileage policies for 2021

In the past, instead of paying a car allowance, some organizations told their employees to just write off vehicle expenses. Others paid a standard company car allowance without calculating whether employees’ expenses were fully being covered – because they knew employees could just deduct their business mileage.

The 2019 tax season brought a rude awakening to these organizations when employees discovered that they could no longer write off their business mileage. This will continue to be the case in 2021 and every year through 2025. Some employers adjusted in 2020 and started paying a car allowance or boosted theirs to compensate for the lost tax deduction. Others did not.

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Now, with road travel down for many employees who receive a car allowance, it is natural to wonder whether it is worth it for employers to sustain or increase their current company car allowance. 

But that's the wrong question. The right question is how to craft an employee vehicle policy that is flexible enough to handle pandemic conditions and keep the company responsive to growth opportunities that could emerge in 2021 as conditions improve.

Reasons to evaluate your car allowance policy

If you own or manage a business that pays a car allowance, you need to take the current uncertainties and pressures facing your employees seriously. If employees feel that their car allowance does not measure up to what they need, they may take measures to shore up their finances in other ways. 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.

  • 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 meet their vehicle expense needs will leave for employers who fully reimburse employee expenses.

Labor Codes

How much car allowance should I pay if employees are driving less?

This is an important question that the pandemic has brought to the forefront. Since a car allowance is designed to offset employee business vehicle expenses, it may seem reasonable to reduce the car allowance during periods when employees drive less. Remember, though, that most vehicle expenses do not directly depend on how much a person drives.

Auto insurance and depreciation, for example, constitute more than 60% of annual vehicle expenses for most American drivers. These two sources of expense are minimally affected by how much a person drives. Other non-operational expenses include personal property taxes, vehicle registration and license fees, and any other taxes or fees that a locality might levy on the vehicle – these must all be paid whether the employee drives a lot or a little.

Employers who continue to prioritize offering a competitive car allowance will find that the benefits outweigh the costs. They provide increased security for their employees during uncertain times and send a message about confidence in future growth opportunities.

But there is a way to save money on your company car allowance while still keeping the amount competitive. It's all about knowing the tax rules for car allowances.

Car allowance tax rules for 2021

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 possible opportunities to save money while offering a competitive car allowance.

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. Your employees may lose 30 to 40% of their allowance to taxes, which raises questions about whether the current monthly amount fully offsets their monthly 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. 

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 2021.

And that's where your organization could find an opportunity to save money, provide a robust vehicle use benefit, and set itself up for growth in 2021. 

Two key changes to your car allowance policy in 2021

Giving the financial pressures that many American workers are facing as well as the uncertainties that many American businesses are facing, it is important that you craft a 2021 car allowance policy that can handle changing circumstances and set the company up for future growth.

1. Go with a non-taxable car allowance in 2021

When an organization paying a taxable car allowance switches to a non-taxable one, often they can leverage the money that no longer goes to the government into savings for the company and better benefits for the employee. The key is to figure out which non-taxable approach best fits your organization.

2. Create a flexible car allowance in 2021

Different employees have different expense needs. Even within a company expenses can vary greatly. And a pandemic that waxes and wanes makes it hard to predict how much employees will actually drive. This requires a car allowance policy tailored to the actual vehicle expense needs of employees, which means that not all employees should receive the exact same amount.

In order to determine which non-taxable policy is best to fit your organization's circumstances and goals and to learn how to tailor the policy to your employees' needs, you need a guide.

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 (taxed), mileage allowances (non-taxed), mileage rates (non-taxed), and fixed and variable rate car allowances (non-taxed).
  • The best method for your organization’s size and goals
  • How to avoid taxation and turn the savings into growth
  • 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

With a complete understanding of these topics, you can determine whether your current policy will meet the needs of the coming year. 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. We'll even provide you with a suggested rate optimized for your organization for free.

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