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Tax Season 2025: Time for a Non-Taxable Car Allowance

Written by mBurse Team Member   |   Feb 5, 2025 7:00:00 AM
2 min read

With inflation running high and employees unable to deduct business mileage on their tax returns, businesses are turning to non-taxable car allowances. The best option is the fixed and variable rate car allowance, or FAVR.

It's 2025 – Still paying a taxable car allowance?

In recent years more organizations have re-evaluated their car allowance policies. Factors include the 2017 tax reform, the tightening of state labor laws, and rampant inflation. The following Q & A will help you evaluate whether a FAVR vehicle program could benefit your organization.

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

How much is a fair car allowance

How is a FAVR allowance different from a standard allowance?

The fixed and variable rate car allowance 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.

Costs covered by a FAVR plan

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

Localized cost data for FAVR plans

Most importantly, 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. 

Different parts of the country face different vehicle costs. Drivers also accrue mileage at different rates, affecting cost calculations. A FAVR plan takes both variables into account when calculating rates.

What are the benefits of a FAVR allowance?

Fixed and variable rates are best practice for organizations with employees that travel 5,000 or more miles a year. This is because standard allowances and mileage rates involve inherent flaws. Overcoming these flaws requires a more sophisticated plan.

Flaws of typical business vehicle plans

  • Around 30-40% goes to taxes (traditional car allowance)
  • Difficulty controlling costs (especially with the IRS mileage rate)
  • Paying the same amount or rate to employees incurring different costs
  • Inability to accurately offset both high fixed costs (e.g. depreciation and insurance) and variations in operational costs (e.g. gas prices)

Benefits of fixed and variable rate plans

Following the 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

Why is FAVR the best car reimbursement?

If FAVR is so great, why don't more businesses use FAVR? A standard vehicle allowance or mileage reimbursement is easy to compute and pay. Most people like to stick with what is familiar and easy to understand. In the business world, it is often easier to tweak a bad policy than adopt a brand new one.

Bad solutions to car allowance problems

When a business vehicle policy causes problems, businesses often add components rather than re-evaluate the policy. These components may include

  • 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 costs over time. 

Good solution: pay a car allowance tax-free

Typically, when people hear about a non-taxable car allowance, they think it’s a tax loophole. It sounds too good to be true. However, FAVR plans can solve nearly every vehicle reimbursement problem organizations face.

By simply removing taxes from the car allowance, an organization gains significant savings and greater flexibility. In many cases under-reimbursed drivers gain a huge benefit while the company saves money overall.

Should our business go tax free in 2025?

Pressures have mounted on employers to offer robust car allowances. With the significant increases in car prices and maintenance costs over the past four years, your employees are looking for ways to boost the take-home amount of their car allowance. Consequently, your car reimbursement will affect your attrition rates.

With an overall cost increase, 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.

How is a FAVR plan administered?

Even though a FAVR vehicle program sounds complicated, it isn't. 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 regulations involve data modeling and 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.

How much does a FAVR program cost?

Thanks to the removal of tax inefficiencies and the precision of the reimbursements, transitioning to FAVR costs less than you think. Typically, the savings will more than offset the expenses of third-party administration. In the first year alone, most companies experience substantial savings due to eliminating tax waste and gaining precise reimbursements.

Calculate savings of IRS non-taxable allowance

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.

Compare my car allowance to FAVR

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