Mileage reimbursements for employees are standard in many industries. The approach is straightforward and seems fair. But the IRS-approved FAVR mileage reimbursement is being touted as a more cost-effective business mileage rate than the published IRS standard rate. Let's compare the two.
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. Many employers use the IRS standard business rate ($.585/mile for 2022), while others use a lower rate they deem more appropriate for their employees.
A FAVR reimbursement, however, combines a mileage rate with a fixed monthly allowance. Both the cents-per-mile and the fixed rate are derived from vehicle expense data localized to the driver's garage zip code. Whereas a standard rate like the IRS mileage rate reflects average vehicle costs, a fixed and variable rate takes into account localized cost differences that change frequently like gas prices.
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?
The short answer is, no. Under a standard mileage reimbursement program, all employees receive the same rate, regardless of location or traffic conditions. An employee in Los Angeles paying almost $6/gallon for gas may get the same 58.5 cents per mile as an employee in Atlanta paying $4/gallon. Unlike fixed and variable rate plans, standard plans do not distinguish between different types of expenses or their relative costs.
Requiring an employee to have a vehicle means that the employer is responsible to reimburse not just operating costs like fuel but also ownership costs. These are the fixed costs the come with owning a vehicle. Month-to-month, they stay roughly the same. Examples:
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.
These are the expenses that more readily come to mind when you think about business travel:
These costs increase the more you drive, just as a mileage rate does. They also can vary dramatically from state to state and according to city vs. highway driving. A mileage reimbursement can reimburse these expenses accurately if and only if the mileage rate is customized to geographic region, driving conditions, and an appropriately sized vehicle for the job.
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.
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 why:
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.
FAVR reimbursement, however, keeps a large portion of the reimbursement separate from miles driven. Remember that fixed costs amount to 60% or more of the average person's annual vehicle expenses. This means that the boost from extra driving or extra reporting is smaller and less of an incentive. (Best practice: use real-time mileage tracking to prevent over-reports.)
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 spread over a larger number of miles and become less expensive per mile.
Because FAVR directly pays for fixed costs, this effect is eliminated. Then, using data, you can calculate the expected mileage-based expenses and set the mileage rate accordingly. A FAVR plan also bases both rates on a standard vehicle appropriate to the job, so rate calculations remain independent of the employee's vehicle choice (i.e. the company does not pay for the extra gas required by a large pickup vs. a mid-size sedan).
Similarly, while a standard cents-per-mile plan under-reimburses low-mileage drivers, a FAVR plan does not. This fairer approach pays dividends in helping retain valuable employees.
If employees are being under-reimbursed, they will either drive or report more mileage or leave the company.
Tax rules that went into effect in 2019 combined with high inflationary costs in 2022 have heightened this effect. Before the 2019 tax season, American tax filers could write off unreimbursed business expenses. But the Tax Cuts and Jobs Act eliminated that popular deduction. And now in 2022, vehicle prices, gas prices, and auto insurance rates have risen significantly.
State labor laws come in to play here. Shortchanged employees 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 at least seven other jurisdictions offer legal protections to employees whose business reimbursements do not fully cover their expenses.
Labor lawsuits are costlier than any other factor. You can increase the mileage rate all the way up to the IRS standard, but that may not be enough in California. Or you can pay an accurate reimbursement in the first place, which means reimbursing both mileage and fixed costs, not just mileage.
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 $.585/mile, the 2022 IRS standard business rate. A FAVR reimbursement is non-taxable as long as the employer follows a set of 28 rules governing the data modeling and the insurance rates and vehicle values used to determine the fixed rate for each employee.
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 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: