[Updated for 2023] When an employee drives a personal vehicle as part of their job, the company typically reimburses the driver for the cost of the business use of the vehicle. 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.
For the vehicle reimbursement to be accountable and non-taxed, you have to demonstrate business use of the mileage being reimbursed. This involves keeping an up-to-date record of each business trip – date, destination, mileage. In the past mileage logs were often paper records, but now more people use mileage tracking apps designed to automate this process.
If the employer pays a mileage rate that exceeds the 2023 IRS business rate (i.e. the federal rate), then the amount over 65.5 cents per mile (multiplied by the mileage) will be considered taxable income. Similarly, if the company uses the IRS rate or less but does not keep appropriate records to substantiate business use of the vehicle for the reported mileage, then the reimbursement should be taxed.
What vehicle expenses does a mileage reimbursement cover?
The business mileage rate published each year by the IRS 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 some problems when it comes to using the IRS mileage rate as a reimbursement tool. (It was actually intended to just be used as a tax deduction tool for individuals.)
A reimbursement for an employee's use of a personal vehicle should cover the business portion of the following expenses (i.e. whatever percentage of the vehicle use is for work):
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
Looking at this list, you might realize that 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? Let's explore that question.
Disadvantages of mileage reimbursements
The primary problem with using a standard mileage rate for all drivers within an organization is that these drivers do not actually 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 per month in order to recover 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 begins to become extra income. If the driver never reaches that number, then their costs are not fully reimbursed for that month.
This creates a problem. 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?
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.
