It is common for businesses to pay the same car allowance or reimbursement to all employees who operate vehicles. But some organizations offer more individualized reimbursements. Which is the right approach?

Should you pay all workers the same car allowance?

On the surface, paying the same car allowance amount or mileage rate to all employees makes sense. It gives the appearance of equality and fairness. If an organization were instead to pay one worker one rate and another worker a higher rate, that first worker might complain about a lack of fairness.

But the reality of vehicle reimbursements is more complicated than paying one set stipend amount or reimbursement rate to all employees. The main issue is whether all workers incur expenses at the same rate. Unless your business operates in one region and its employees drive similar amounts each week, chances are high that they incur expenses at different rates.

If employees incur expenses at different rates, then it no longer makes sense to pay each one the same monthly car allowance or the same mileage reimbursement rate. That arrangement would be equal, but not equitable.

Problems with paying an equal car allowance

Here is a list of the problems that may ensue from paying an equal car allowance to all employees who use their own cars for work:

• Drivers in expensive locations may be under-reimbursed
• Higher mileage amounts do not yield a higher allowance
• Paying an equal amount for unequal expenses hurts morale
• Undercompensated workers may drive less or quit their jobs

Because a standard car allowance does not increase or decrease with mileage amounts, there will always be disparities between high-mileage and low-mileage drivers. And because it is not based on localized expense data, workers in different locations may experience widely different take-home pay even for relatively similar mileage amounts.

When you add in the fact that most car allowances are treated as taxable income, what seems like a sufficient amount may not be sufficient for all employees after tax withholding.

Problems with paying an equal mileage rate

Issuing a mileage reimbursement can avoid two of the problems with car allowances. First, as long as the mileage rate is equal to or less than IRS business rate (67 cents per mile for 2024), the payments are tax free. Second, payments track with mileage amounts, so there will be a closer match between mileage-based expenses and reimbursement amounts.

However, there is still a set of problems that can ensue:

• Workers in expensive locations may be underpaid
• Workers in inexpensive locations may be overpaid
• High-mileage drivers will tend to be over-reimbursed
• Low-mileage drivers will tend to be under-reimbursed

These four problems are tied to the fact that paying one equal mileage rate to all employees assumes a similar rate of incurring expenses. The IRS business mileage rate, for example, is based on average costs and average annual mileage amounts nationwide. Using that rate, a driver who drives an average amount in a part of the country with average expenses will get a fair reimbursement. But a driver in a more expensive place, such as California, may be under-reimbursed relative to a driver in an inexpensive place like Ohio or South Carolina.

The other problem is that mileage rates, while good at reimbursing mileage-based expenses like gas and maintenance, are not good at reimbursing fixed expenses like insurance and depreciation. This is what results in the disparity between high-mileage and low-mileage drivers.

Best practices for reimbursing all co-workers for vehicle use

To avoid the inequalities created by paying an equal car allowance or mileage rate, here are some best practices to follow.

1. Determine the range of employees' actual vehicle expenses.

For a company operating in a single region with workers driving similar amounts, a single car allowance amount or mileage rate may be fair to all workers. But you cannot know this without estimating the actual expenses incurred by drivers. Companies with a wider variety of locations and mileage amounts will have a wider range of expenses. But you need to get a sense of this range before architecting a new vehicle reimbursement policy.

2. Adopt a tax-exempt car allowance policy.

Adopting a tax-exempt vehicle reimbursement gives an organization the greatest financial flexibility to ensure fair payments to all workers. If an organization pays a taxable car allowance, removing the tax waste can free up funds to increase payments to any underpaid drivers under a new plan. Non-taxable methods include mileage reimbursements at or below the federal rate, a fixed and variable rate policy (aka FAVR), or mileage substantiation for a car allowance (aka a mileage allowance).

3. Use data to determine the appropriate rates.

For most organizations, the fairest arrangement will require more than one rate, depending on different workers' locations. This requires access to localized vehicle expense data. It is also important to calculate rates based on a standard vehicle appropriate to the job, rather than the actual vehicle being driven. This is because different vehicles will vary in fuel efficiency, how much they cost to insure and maintain, and how rapidly they depreciate. Vehicle expense data is available affordably from vendors that specialize in vehicle reimbursements.

4. Calculate fixed costs separately from variable (mileage-based) costs.

Fixed costs like insurance premiums, depreciation, and state/local taxes and fees, can easily be calculated separately for each driver. Using a standard vehicle garaged in a specific zip code, you can derive these amounts and establish a baseline payment for each employee. The mileage-based costs (e.g. fuel, maintenance, tires) will vary more, which is why they should be calculated separately. The only reimbursement method that automatically calculates both sets of expenses is a FAVR plan (aka fixed and variable rate allowance).

Adopting a fair, tax-exempt vehicle allowance for all employees

Adopting a new policy can be a challenge. Most organizations that adopt the four best practices outlined above partner with an expert to design and implement a fair and professional vehicle allowance policy.

To learn more, you can start by comparing your current program with a sample FAVR vehicle plan designed by mBurse for its partner organizations.