[Updated for 2023] 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?
The answer is, it depends. Typically, the reimbursement stays non-taxable as long as the mileage rate used for reimbursement does not exceed the IRS standard business rate ($0.655/mile for 2023). But this assumes that other rules are being followed to make the reimbursement part of an accountable plan.
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 2023 IRS business rate and properly tracks mileage, the payments are tax-free. If the rate exceeds the federal mileage rate, then the amount over $0.655/mile (multiplied by mileage) will be taxable income. If the company pays the IRS rate or less but does not keep appropriate records of business mileage, then the reimbursement should be taxed.
What vehicle expenses should a non-taxable mileage reimbursement cover?
The IRS business rate published each year is based on the average costs of owning and operating a vehicle in the U.S. for the previous year. 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 actually designed to calculate individual tax deductions.)
A reimbursement for an employee vehicle should cover the business percentage of the following expenses:
Depreciation (higher in newer cars; keep in mind if employer requires a newer car)
Taxes, license, registration
Vehicle Operation Costs
Some of these costs are higher in certain parts of the country than others. (California's gas prices and Michigan'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. Not only do some live in more expensive areas than others, but some drive a lot more than others.
In order for a mileage reimbursement to work, a driver has to drive a certain number of miles to cover that month's portion of the ownership costs of the vehicle. After reaching that amount, then 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, by the way!). If the driver never reaches that number, however, their costs are not fully reimbursed for that month.
This is an inequitable situation. And if the company has lots of high-mileage drivers, it might even be an unaffordable situation. (Especially if they are manually reporting their mileage, allowing extra miles to be buffered in.)
Mileage reimbursement problems and solutions in 2023
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 200 miles per month for work will only get reimbursed $131 per month. Will this cover gas and insurance costs? What about the other work-related vehicle costs? A different approach is needed – one that addresses both ownership and operation costs, that accurately reimburses different employees at different rates based on their location, and that eliminates inequitable discrepancies between reimbursements.
Non-taxable mileage reimbursement alternatives
In order to solve the problems with mileage reimbursements while still keeping the plan accountable and non-taxed, 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 better option is called fixed and variable rate reimbursement, or FAVR.
To learn more about this accountable plan select the button below.