Tax Season: Time for a Non-Taxable Car Allowance

Written by mBurse Team Member Mar 9, 2020 7:15:00 AM

The 2019 tax season placed taxable car allowances under increased scrutiny because employees could no longer deduct business mileage to offset their taxes. Businesses are now turning to non-taxable plans, and the best one is the fixed and variable rate car allowance, or FAVR.

It's 2020 – are you still paying a taxable car allowance?

In the wake of the tax reform and recent tightening of state labor codes, more organizations are re-evaluating their car reimbursement policies. The following Q & A will help you evaluate whether a FAVR vehicle program could benefit your organization.

FAVR, an IRS-approved alternative to a taxable car allowance, accurately reimburses employees for the use of a personal vehicle for work. Based on our 2019 Car Allowance Survey, a lot of drivers are frustrated with their taxable car allowances and are looking for employers who use a more equitable method such as FAVR.

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How is a FAVR car allowance different from a standard car allowance?

The fixed and variable rate car reimbursement or FAVR (fa·vor /ˈfāvər/) is a non-taxable vehicle reimbursement for businesses. The IRS has created a set of procedures that keep a car reimbursement plan non-taxable. Section 8 details these guidelines for FAVR reimbursements.

This expense offset plan reimburses mobile employees exactly how they incur costs. Employees receive a fixed amount each month (like a car allowance) to cover fixed costs like

  • Insurance
  • License
  • Registration
  • Depreciation 

Employees also receive a variable amount (based on mileage) to cover variable costs:

  • Gas
  • Oil
  • Maintenance
  • Tires

Most importantly, both the fixed amount and the variable rate are indexed to the geographical cost data for the employee's garage zip code. This ensures that each employee receives a fair car reimbursement for their part of the country and the amount of mileage they accrue.

What are the benefits of a FAVR reimbursement?

While still relatively unknown to many organizations that pay a car allowance, fixed and variable rate is increasingly considered best practice for organizations with mobile employees that travel 5,000 or more miles a year. This is because standard allowances and mileage rates involve inherent flaws that require a more sophisticated plan to correct. Flaws of typical business vehicle plans include

  • Significant amount goes to taxes (traditional car allowance)
  • Difficulty controlling costs (especially with IRS mileage rate)
  • Paying the same amount or rate to employees incurring different costs
  • Inability to accurately offset both large fixed costs (e.g. depreciation and insurance) and variations in operational costs (e.g. gas prices)

Following IRS guidelines for fixed and variable rate allowances brings five important benefits:

  1. No taxes – all of the payment goes to reimbursement
  2. The reimbursement rates are based on data
  3. Geographically cost sensitive and able to address cost variances
  4. Completely customizable and flexible (and scalable!)
  5. Cost control through an equitable reimbursement

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Why choose FAVR rather than another reimbursement alternative?

In other words, if FAVR is so great, why don't more businesses use FAVR as their reimbursement policy? Even though most organizations still reimburse with outdated policies for the sake of convenience, FAVR is on the rise. A standard vehicle allowance or mileage reimbursement (such as the IRS business mileage rate) is easy to compute and easy to pay out. And let’s be honest, most of us like to stick with the way things have always been done rather than exert the time and effort required to make policy changes.

When businesses find that their vehicle reimbursement policy is creating problems, such as under-reimbursement or over-reimbursement, they often just add other components, rather than re-evaluate the whole policy. These components often take the form of

  • Car allowance + fuel reimbursements or fuel cards
  • Car allowance + mileage reimbursements
  • Mileage allowances (mileage substantiation)

However, though simple and easy to administer, these DIY vehicle reimbursement programs often work against business objectives and increase the organization’s risk (and costs!) over time. 

Typically, when people first hear about a non-taxable car allowance with a reimbursement, they think it’s a tax loophole or simply not true. It may sound too good to be true, but FAVR plans can solve nearly every vehicle reimbursement problem organizations commonly face.

Why should my business switch to a non-taxable car allowance now?

Last tax season was the first time employees realized they could no longer write off unreimbursed business expenses. This change has made vehicle reimbursements more of a priority. It is more important now in 2020 than ever that employees are reimbursed accurately and most importantly not taxed. Your car reimbursement will actually affect your attrition rates.

In the past, receiving a car allowance meant you could claim a tax deduction on your business mileage. With the loss of this substantial deduction, employees are taking other measures to secure their income. They may raise complaints with their employers (as our survey found), drive less to save money, drive more (if they receive a mileage reimbursement), or find employment at a competitor with a more equitable reimbursement plan.

Compounding the tax reform changes are states with expense indemnification clauses. More states are adding clauses to their labor codes that ensure employees are reimbursed properly for out of pocket expenses. The upcoming years could bring an uptick in the number of expense indemnification lawsuits as well as states adopting these laws. Penalties and fines under state labor codes will likely increase as the tax reform increases the attention on equitable reimbursement practices.

The truth is, a standard vehicle allowance or mileage rate just won’t cut it on this side of the tax reform. 

How is a FAVR car allowance program administered?

Even though a FAVR vehicle program sounds complicated, it really isn't. To properly deliver a fixed and variable rate allowance, most organizations outsource administration to a third party. The IRS has instituted 28 rules that make FAVR reimbursements accountable plans, which adds to their complexity. The majority of the rules involve data modeling and the geographical cost designs. Think of a FAVR vehicle program as similar to healthcare. Most companies outsource their healthcare benefits rather than trying to administer them internally.

Fortunately, because of the elimination of tax waste and the accuracy of the reimbursements, switching will more than cover the costs of third-party administration. In fact, most companies realize significant savings during the first year.

To learn more about how FAVR could help your business meet its objectives, contact mBurse today. Or try our calculator below to see how much your organization could save by going non-taxable.

Car allowance vs. FAVR Reimbursement

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