Why Mileage Rates Are Reimbursement, Not Compensation

Written by mBurse Team Member Sep 8, 2020 7:00:00 AM

A mileage reimbursement is not a form of compensation – it is a way to keep employees from shouldering costs that rightly belong to the employer. Yet many employees treat their reimbursement as a way to make money. Let's explore why this is a problem and why it's time to re-narrate the function of a mileage rate.

The 2020 IRS mileage rate as a reimbursement tool

The 2020 IRS mileage rate is 57.5 cents per mile. This is slightly less than the 2019 rate ($.58/mile) but higher than the 2018 rate ($.545/mile). Employee drivers will be happy, but the rate increase will not solve problems with using the IRS rate as a vehicle reimbursement method. 

If you are paying the IRS mileage rate, keep in mind that your employees may see it more as a compensation than as a reimbursement. This is a misconception that can significantly impact company costs.

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For instance, in January 2019, when the IRS rate increased from 54.5 cents-per-mile to 58 cents-per-mile, many employees would have perceived that as a raise. For the average driver, that increase of 6.42% represented a raise of over $500 annually, unless their annual vehicle expenses actually increased by 6.42% or more.

Let’s do the math.

The average mobile employee travels 15,248 business miles annually. Compare that employee’s annual reimbursements for 2018 and 2019:

2018 mileage rate ($.545/mile) – $8,310.16

2019 mileage rate ($.58/mile) – $8,843.84

One of the most important factors in the IRS mileage rate is gas prices. But were gas prices actually higher in 2019 over 2018? No, not at all! Though the price fluctuated, the overall 2019 average was $2.60/gallon, a bit below the average gas price for 2018, which was $2.71/gallon.

Why the mismatch?

In a nutshell, the IRS standard business mileage rate represents an average of the previous year’s vehicle ownership and operation costs. The rate increased in 2019 due to a nationwide average cost increase in three specific areas:

  1. Gas
  2. Insurance
  3. Maintenance

Then, in 2020, the rate only slightly decreased – to 57.5 cents-per-mile. It was anticipated that gas prices would hold steady. But that's not what happened, with the Saudi-Russian "oil war" and the steep decline in demand due to COVID-19 lockdowns. As of September 5, 2020, the average gas price across the U.S. was $2.22/gal

Reimbursement problems for IRS standard rate

This annual-average plus expected-average basis for the IRS rate unearths the first of three major problems with using the IRS rate to reimburse mobile employees:

Flaw #1: The IRS standard rate cannot supply accurate  mileage reimbursement rates.

The IRS rate only delivers accurate results for drivers who fit the profile of last year’s “average” American driver. But within one organization you could have multiple drivers whose vehicle costs significantly exceed the average and multiple drivers whose costs lie well below the average. 

The IRS mileage rate under-reimburses low-mileage drivers and over-reimburses high-mileage drivers. This has to do with the large percentage of fixed vehicle costs (depreciation, insurance, taxes, etc.) that are not fully reimbursed until a driver has driven a certain number of miles.

Inaccuracies also arise because the rate is derived from last year’s costs. Because the IRS rate is not tied to current gas prices, it will always have a tendency to over-reimburse or under-reimburse unless gas prices remain flat (and they rarely do).

The IRS mileage rate was designed to be a tax deduction tool, not a vehicle reimbursement rate. It represented the maximum amount you could write off without substantiating business expenses. But it’s so convenient to use it for vehicle reimbursements that many companies throughout the U.S. use it to their detriment.

Flaw #2: With a mileage rate, employees control their reimbursement amount and company costs.

Let’s talk about why employees treat the IRS mileage rate as a form of compensation. It’s a matter of incentive. The more mileage you drive or report, the more you will receive each month. Because the rate is not tied to current gas prices or employee productivity, the company often takes a loss.

Depending on how your company tracks mileage, your employees may not even have to drive more in order to give themselves a raise. Self-reporting can allow them to buffer their mileage or over-estimate it.

The bottom line is, a mileage reimbursement rate quickly turns into a form of compensation, but not a compensation for increased productivity. This is not a sustainable model if you want to stay in the black. 

Flaw #3: The IRS rate is not suited for large fluctuations in mileage or periods of decreased driving.

The year 2020 has thrown everyone for a loop, with the coronavirus pandemic forcing many workers to stay home rather than accrue business mileage at normal rates. Some workers are back to normal driving, while others only travel sparingly, and others remain working from home. 

In a situation like this, a standardized mileage rate simply cannot stay responsive to the changing needs of employees receiving a vehicle reimbursement. Even worse, if an employee is driving significantly fewer business miles per month than usual, then there's a good chance the mileage reimbursement is failing to cover their costs.

That's because their fixed vehicle costs (insurance, depreciation, etc.) remain relatively stable during periods of reduced travel, but in order to get reimbursed for those costs, they have to accrue a certain amount of mileage.  (Learn more about this dynamic in our post on the importance of reimbursing insurance and depreciation.) 

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How to fix a company mileage reimbursement

If you don’t take steps to control your costs, things can get out of hand quickly. But if you under-reimburse valuable employees, you'll face another set of problems.

Here are two steps you can take to protect the company from the flaws of a mileage reimbursement rate.

  1. Switch from mileage reimbursement to a fixed and variable rate plan.

Switch to a vehicle reimbursement policy that accurately reimburses employees based on their costs. The best one is the fixed and variable rate reimbursement, or FAVR. You will never over- or under-reimburse employees.

A FAVR plan will also provide the flexibility needed to stay responsive to the fallout of the COVID-19 pandemic. Employees will always be taken care of fairly, whether they drive a lot or very little.

  1. Adopt a GPS mileage tracker to keep your vehicle reimbursements accurate.

Using a GPS-enabled mileage app will remove the controls of self-reported mileage. This will put an end to mileage buffering. But you should still check each employee’s mileage against their productivity.

If you don’t take steps to adjust either your mileage rate or your mileage log, you will perpetually remain at the mercy of the IRS rate and of employee behavior.

Remember, a mileage reimbursement is a reimbursement, not compensation. Don’t let your employees treat it that way.

Everything you need to know about mileage tracking

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