Mileage reimbursements for employees are pretty standard in many industries. The approach is straightforward and seems pretty fair. But the IRS-approved FAVR mileage reimbursement is being touted as a more cost-effective way to deliver accurate reimbursements. Let's compare the two.
Fixed and variable rate (FAVR) vs. a standard mileage reimbursement
Under a typical mileage reimbursement plan, an employee keeps track of business mileage, submits it to the employer, and receives a payment equal to the mileage multiplied by a cents-per-mile rate determined by the company. While many employers use the IRS standard business rate ($.58/mile for 2019), many others use a lower rate that they deem more appropriate for their situation.
A FAVR reimbursement, however, pays both a mileage rate and a fixed monthly amount. Both the cents-per-mile rate and the fixed amount are derived from vehicle expense data localized to the driver's garage zip code. Unlike a typical mileage reimbursement, this approach delivers accurate payments to all employees because it's based on actual data.
Both mileage reimbursements and FAVR plans are intended to cover all business vehicle expenses relevant to an employee's work. This would include gas, insurance, depreciation, maintenance, oil, and more. The question is, do standard mileage rates and FAVR reimbursements truly cover all these expenses effectively?
Do mileage rates reimburse as effectively as FAVR programs?
The short answer is, no. Under a standard mileage reimbursement program, all employees receive the same cents-per-mile rate, regardless of where they live or how much they use their vehicle. Unlike a fixed and variable rate reimbursement, these plans do not distinguish between different types of expenses or their relative costs.
Fixed costs (ownership expenses)
Requiring an employee to have a vehicle means that the employer is responsible to reimburse not just operating costs but also ownership costs. These are the fixed costs the come with owning a vehicle. Month-to-month, they stay roughly the same. Examples:
- Car insurance
- Value depreciation
- Taxes, registration, and license
A mileage reimbursement increases the more you drive, unlike these expenses. If two drivers have the same ownership costs but one drives a lot more than the other, that second driver will receive a disproportionately larger reimbursement. This is a big deal because fixed costs represent 60 - 70% of the average driver's vehicle expenses. Paying only a mileage rate practically leaves these expenses out of the equation.
Variable costs (operational expenses)
These are the expenses that more readily come to mind when you think about business travel:
- Oil and tires
These costs increase the more you drive, just as a mileage rate does. A mileage reimbursement does an excellent job reimbursing these expenses – assuming the mileage rate is customized to the driver's geographic region and an appropriately sized vehicle for the job.
Fixed and variable rate reimbursement vs. fixed and variable costs
Unlike a standard mileage rate, a FAVR reimbursement divides employee expenses into these two categories and reimburses them separately. A fixed monthly amount goes toward precise projections of the fixed costs. A variable cents-per-mile rate multiplied by the monthly mileage goes toward the variable costs.
This allows you to reimburse both low-mileage and high-mileage drivers accurately and equitably. The fact that the rates are based on geographically defined expense data also allows you to reimburse workers in different regions accurately and equitably.
Does FAVR pay more than mileage reimbursement?
Because a FAVR vehicle plan pays both a fixed allowance and a mileage rate, it seems like it will be costlier than a standard mileage reimbursement plan. But this is unlikely unless a company is already significantly under-reimbursing its employees. Three reasons FAVR tends to be more cost-effective than mileage reimbursement:
1. Mileage reimbursement encourages "driving for dollars"; FAVR does not.
When an employee's entire vehicle reimbursement derives from mileage, there's a strong incentive to drive more than necessary or over-report mileage. The more miles you drive (or report), the more you get paid. This is especially a problem if employees use a self-reported mileage log.
Fixed and variable rate reimbursement, however, keeps a large portion of the reimbursement separate from miles driven. Remember that fixed costs amount to 60 - 70% of the average person's annual vehicle expenses. This means that the boost from extra driving or extra reporting is much smaller and less of an incentive. (It can also help to use real-time mileage tracking to prevent over-reported mileage.)
2. Mileage reimbursement overpays high-mileage drivers; FAVR does not.
Depending on the mileage rate, at a certain mileage amount a driver's reimbursement will outstrip their vehicle costs. This is because the fixed expenses are being spread over a larger number of miles and therefore become less expensive per mile.
Because FAVR reimbursements directly address fixed costs with a fixed payment, this effect is eliminated. Using data, you can figure out what the mileage-based expenses should be and set the mileage rate accordingly.
Of course, the flip side of this is also true. While a standard cents-per-mile plan under-reimburses low-mileage drivers, a FAVR plan does not. So that increased expense could cancel out the decrease in overpayment. But which is better – unfair reimbursements or fair reimbursements?
3. Unfair mileage reimbursements do not retain employees and may break the law.
These two problems with mileage reimbursements will prove the costliest in the long run. If employees are being under-reimbursed, they will either drive/report more mileage or leave the company. Both hurt the bottom line.
New tax rules will heighten this effect. Before the 2019 tax season, American tax filers could write off unreimbursed business expenses. But the tax reform eliminated that popular deduction. Companies cannot under-reimburse employees and then say, "Write it off on next year's taxes."
State labor laws come in to play here. As more employees get shortchanged, more of them may turn to labor codes for recourse. Several states require employers to fully reimburse vehicle expenses. California and Illinois have two of the strictest laws, and other states may follow suit.
Labor lawsuits are costlier than any other factor. You can increase the mileage rate all the way up to the IRS standard rate, but that will increase costs anyway. Or you can pay an accurate reimbursement in the first place, which means reimbursing both mileage and fixed costs, not just mileage.
What are the 2019 tax rules for mileage reimbursements and FAVR?
As we've already established, the elimination of the business expense deduction went into full effect the spring of 2019. And a FAVR reimbursement plan is better positioned to address this change than just a mileage rate by itself.
But the good news is that both approaches to vehicle reimbursement are tax-free, as long as certain IRS rules are followed. A mileage reimbursement is non-taxable as long as the rate doesn't exceed $.58/mile, the 2019 IRS standard rate. A FAVR reimbursement is non-taxable as long as the employer follows 28 rules governing the data modeling and the insurance rates and vehicle values used to determine the fixed rate for each employee.
A disadvantage of FAVR reimbursement
In all previous comparisons, the fixed and variable rate approach has trumped the traditional approach to reimbursement. However, FAVR does come with one significant disadvantage: it's complicated to administer.
Because accurate reimbursements require accurate data, and because the IRS has published a complex set of rules governing that data, many employers are deterred from updating their reimbursement policy with a FAVR approach.
However, a number of partner organizations exists that specialize in FAVR administration. These organizations, including mBurse, craft FAVR policies in conjunction with the client company's goals and mission and then manage them at an affordable rate.
The benefits make the switch worth it:
- Long-term cost control
- Equitable reimbursements
- Increased retention and attraction of talent
- Protection from labor code violations
- Increased employee productivity