When deciding on a mileage reimbursement rate, many companies look for guidance to the published standard mileage rates from the IRS. But the question of whether to pay that exact rate to employees is actually kind of complicated.
Is it okay to pay less than the IRS mileage rate?
Let's first establish that reimbursing with the IRS standard business rate is entirely optional for employers. When the IRS raised its 2022 rate to 62.5 cents per mile, and then set its 2023 rate to 65.5 cents per mile, it got a lot more expensive to use for reimbursements. But that rate is just a guideline.
The published rate serves as a guideline for establishing whether a car reimbursement can remain non-taxable. A company can pay more or less if it so chooses, but it is important to know the consequences of each choice.
Paying a mileage rate equal to or less than the IRS standard keeps the reimbursement tax-free to employees, as long as the company keeps timely and accurate records of business trips and mileage for each employee. Paying more than the IRS rate results in taxes on the portion of the reimbursement that exceeds the published rate.
Some employers may choose to pay less than the IRS rate in order to save money. They might, for example, choose a FAVR rate. Others may pay a lower rate because they do not believe employee vehicle costs are high enough to warrant it. The question is, how do you know for sure?
The IRS mileage rate and labor code violations
Some states have reimbursement laws that encourage employers to reimburse at the IRS safe harbor rate. California Labor Code 2802, for example, requires full reimbursement of all employee business expenses. In the past, the IRS mileage rate has been seen as sufficient to cover these expenses, protecting companies from incurring labor code violations.
This means that companies operating in California and other states with employee indemnification labor codes could find themselves in violation of the law if they reimburse at less than the IRS rate. That makes it important to know the labor laws of states where your employees operate.
At the same time, the IRS mileage rate is not 100% foolproof in very expensive locations, such as many parts of California. If an employee can prove that their vehicle costs exceed their reimbursement amount, they can sue the employer to recover the deficit. A low-mileage or mid-mileage driver in an expensive location might not be able to accumulate a high enough reimbursement amount each month to cover all vehicle costs.
When should a company pay a different rate from the IRS mileage rate?
Here are three situations in which an employer should NOT pay the IRS mileage rate for employee reimbursement.
1. If employees will not receive a sufficient reimbursement at the IRS rate
If an employer is concerned that some employees may not receive a sufficient reimbursement at the IRS rate, then they should explore other options. This is especially important if these employees operate in a state with strict labor laws. But it is important to consider non-taxable options, since taxation only adds further costs to the company and reduces employee take-home pay.
2. If employees experience a wide range of business vehicle costs or work in different regions
The number one problem with paying a standard rate like the IRS rate is its inability to account for wide variations in employee vehicle costs. If all employees drive relatively similar mileage amounts and work in regions with relatively similar gas prices, insurance rates, and maintenance costs, then the IRS rate might work, assuming that $.655/mile multiplied by the average mileage amount is roughly equal to those vehicle costs.
But if some employees drive 2000 miles per month while others drive only 1000, that's going to make a huge difference in their rate of incurring costs. The discrepancy will grow if some employees work in expensive regions while others do not. You could be violating a labor code in one state while significantly over-reimbursing an employee in another state!
3. If employees report their own business mileage manually or on a spreadsheet
One reason some businesses pay less than the IRS rate is to rein in costs. If employees have a lot of discretion over the reporting of business mileage, they may "guesstimate" or buffer their mileage in order to boost their income.
This makes it crucial to switch to one of the newer mileage tracking systems that help reduce inaccurate mileage calculations and reports. The mLog app, for example, uses GPS technology to record employee mileage in real-time – though the mileage is not reported in real-time in order to protect privacy of drivers.
Mileage reimbursement that's better than the IRS rate
In order to avoid overpaying, underpaying, violating labor codes, or incurring taxes, your organization should consider an alternate reimbursement method:
This alternate IRS-approved method is also tax-free but holds the advantage of delivering reimbursements based on the varied expense levels of different employee zip codes.
Fixed and variable rate reimbursement also does a much better job protecting employers from infringing on labor laws, leaving employees under-reimbursed, or over-reimbursing high-mileage employees. This is because it combines a smaller mileage rate with a flat monthly payment calculated for each employee.
To learn more about FAVR and how it could work for your organization, follow the link below, or schedule a discovery call with mBurse.