[Updated for 2024] What are the tax rules for mileage reimbursements? Many employers pay a cents-per-mile rate because it is simple to calculate. But it is important to know the IRS rules about taxation of vehicle reimbursements.
Is a mileage reimbursement taxable income?
Typically, a mileage reimbursement stays non-taxable as long as the cents-per-mile rate used does not exceed the IRS standard business rate ($0.67/mile for 2024). But this assumes that other rules are being followed to make the reimbursement part of an accountable plan.
The IRS has also approved an alternate tax-free reimbursement system called fixed and variable rate (FAVR). We'll explore tax rules for mileage reimbursements first and then see why FAVR has become preferred by many businesses.
What makes a mileage reimbursement non-taxable?
For the vehicle reimbursement to be accountable and non-taxed, you have to demonstrate business use of the mileage being reimbursed. This requires an up-to-date record of each business trip – date, destination, mileage. In the past mileage logs were paper records or Excel spreadsheets, but now more people use mileage tracking apps designed to automate the process.
If the employer pays a mileage rate equal to or less than the 2024 IRS business rate and properly tracks mileage, the payments are tax-free. If the rate exceeds the federal mileage rate, then the amount over $0.67/mile (multiplied by mileage) will be taxable income. If the company pays the IRS rate but does not properly track mileage, then the payments are taxable.
What vehicle expenses does a mileage reimbursement cover?
The IRS business mileage rate published each year is based on the average costs of owning and operating a vehicle in the U.S. Because these costs are averaged from across the country, they apply more to some drivers than others, which can create problems when using the IRS mileage rate to calculate reimbursements. (It was designed to calculate individual tax deductions.)
A reimbursement for an employee vehicle should cover the business percentage of the following expenses:
Vehicle Ownership Costs
- Auto insurance
- Depreciation (higher in newer cars; keep in mind if employer requires a newer car)
- Taxes, license, registration
Vehicle Operation Costs
- Fuel
- Oil
- Maintenance
- Tires
Some of these costs are higher in certain parts of the country than others. (California's gas prices and Louisiana's auto insurance premiums, for example.) Should drivers in expensive locations receive the same mileage reimbursement rate as drivers in inexpensive places?
What mileage rate should be used for tax-free reimbursements?
Paying a standard rate like the IRS rate may be tax-free, but it is not problem-free. Drivers do not incur costs at the same rate. Some live in more expensive areas than others, and some drive a lot more than others.
For a mileage reimbursement to work, a driver has to drive a certain number of miles to cover that month's portion of the vehicle ownership costs. After reaching that amount, the mileage-based costs like fuel, oil, and maintenance will start being reimbursed.
At some point, the mileage multiplied by the mileage rate will exactly equal the combined set of expenses for that month. Once the driver reaches that magic number, each mile driven becomes extra income (tax-free income, no less!). But if the driver never reaches that number, their costs are not fully reimbursed.
This creates an inequitable situation. A high-mileage driver may end up being over-reimbursed, while a low-mileage driver may end up under-reimbursed. What if that second person drives fewer miles because they work in an urban area, likely expensive? And what if the first person drives a lot because they cover a large, less populated territory, probably less expensive?
Mileage reimbursement problems and solutions in 2024
Mileage reimbursements do not work for all employees. Employees who cover small territories, especially if they live in expensive areas, often cannot accrue enough miles to pay all their vehicle expenses.
An employee who drives only 500 miles per month for work will only get reimbursed $335 per month. Will this cover the business portion of gas, insurance, depreciation, maintenance, etc.? A different approach is needed – one that addresses both ownership and operation costs, that reimburses different employees at different rates based on location and eliminates inequitable discrepancies.
Non-taxable mileage reimbursement alternatives
To solve problems with mileage reimbursements while keeping a plan tax-free, the IRS has offered some solutions. One is a mileage allowance, or a car allowance paired with mileage tracking for substantiation. This approach has serious flaws which you can read about here.
The other, better option is called fixed and variable rate, or FAVR.
To learn more about this alternate IRS-recommended plan select the button below.
