Why the IRS Mileage Rate Cannot Guarantee Compliance with Labor Codes

Written by mBurse Team Member   |   Jun 6, 2022 7:00:00 AM
4 min read

For companies that pay a vehicle reimbursement to employees, the IRS mileage rate has often been viewed as the gold standard. However, the mileage rate's lack of transparency is causing employers nationwide to look for a more defensible, equitable reimbursement method.

The IRS mileage rate and state labor code compliance

As we pointed out in our previous post, paying the IRS mileage rate increasingly puts employers in the position of violating California Labor Code, Section 2802(a). This is because the costs of owning and operating a vehicle in California are greatly outpacing the average costs nationwide, and the IRS rate, or "government rate," is based on national averages.

This situation is being exacerbated by the high gas prices workers are experiencing in 2022. At the start of June, California workers are paying $6.34 per gallon on average. The average price per gallon across the country is $4.86. Both of these numbers greatly exceed the prices when the IRS announced its 2022 mileage rates back in December of 2021.

Originally California's employee indemnification labor code was instituted to protect the income of pizza delivery drivers. Pizza delivery drivers' costs were eclipsing their pay, reducing it below the minimum wage. Labor Code 2802(a) obligates employers to reimburse employees for “all necessary expenditures or losses incurred by the employee" – including vehicle expenses. 

Labor Code self audit

In 2007, the California Supreme Court ruled in GATTUSO v. HARTE-HANKS SHOPPERS, INC that the law protects not only pizza delivery drivers, but also professional sales reps, merchandisers, light service repair reps – basically any employee driving a personal vehicle for business use. 

In the intervening years, more and more states have passed similar employee indemnification laws, with Illinois becoming the latest with its updated Wage and Payment Protection Act of January 2019.

As states move to protect mobile employees from employer expenses, companies nationwide face renewed pressure to prove that their reimbursement rate fully covers business vehicle costs. The problem is, the IRS standard rate doesn't work that way. It's based on average national costs from the previous year.

No employer, when faced with questions from an employee, can pull out numbers comparing the employee's expected vehicle costs and their mileage times $.585/mile (the 2022 IRS mileage rate). The rate isn't derived from cost data specific to any employee's context, so how can you stand behind it when an employee claims that the rate isn't keeping up with costs?

You can't. And that's a huge problem. Employers instead need to adopt new practices to ensure their mileage rate complies with California's labor code. This is especially true now that high gas prices seem poised to remain for the foreseeable future.

Why do businesses reimburse with the IRS rate?

The fact is, employers choose the IRS rate because it's simple to understand and easy to administer. Employees receive a tax-free reimbursement that in some cases ends up reimbursing beyond what they need.

But sometimes the IRS standard rate leaves business drivers exposed – especially low-mileage drivers, because they don't accrue enough miles X $.585 to be able to cover their fixed costs (e.g. depreciation and insurance) on top of their driving costs (e.g. fuel and oil).

In expensive parts of the country, mid-mileage drivers also find the IRS rate falling short. This annually adjusted rate was never designed to govern employee reimbursements. Instead, it represents last year's estimated average cost of owning and operating motor vehicles across the entire country. Using an average of widely varying vehicles is fine for calculating tax deductions. But it's not fine for mileage reimbursements.

computer mouse selecting three steps

The IRS standard rate is an individual taxpayer’s tool, not a corporate reimbursement tool. And that's why it will let you down.

This imprecision means that employers cannot look their employees in the eye and guarantee they they are covering their costs. That's a legal problem in states with indemnification laws, and an ethical problem everywhere else.

The non-quantifiable IRS mileage rate and its inequities

Exacerbating the trust problem are the reimbursement disparities created by the federal mileage rate.

Let’s look at two employees that live next door to each other, drive the same vehicle, and are both reimbursed using the IRS mileage rate:

  • Employee A drives 5,000 annual business miles and is reimbursed $2,925.00
  • Employee B drives 30,000 annual business miles and is reimbursed $17,550.00 

Both employees pay the same amount for their driver’s license, vehicle taxes, and similar car insurance. The high-mileage driver, Employee B, will spend more on maintenance and tires and a lot more on gas. But Employee B is not going to spend $14,625.00 more in gas, maintenance, and tires than Employee A. This is a huge disparity, and it happens all the time. 

Employee A has grounds to argue that the IRS mileage rate does not fairly reimburse and has violated that employee’s rights under CA Labor Code 2802(a), or the Illinois Wage and Payment Protection Act, or any other state labor code that indemnifies employees from business expenses. All Employee A has to do is pull actual costs and compare them to the rate they received. For large organizations with quite a few low- or mid-mileage drivers, a class action lawsuit could be established.

In a state without strict labor laws, you still have to deal with employees' questions, complaints, and departures over inequities like this. You want to treat your employees fairly, and you want your best employees to stick around for a long time. A fair, transparent, defensible reimbursement method is crucial to ensure this trust.

21st century mileage capture

Fixed and variable rate reimbursement (FAVR)

The most transparent, quantifiable reimbursement method that's also cost-effective and feasible administratively is the fixed and variable rate reimbursement (FAVR).

A FAVR vehicle program reimburses employees exactly in the same manner that they incur costs – fixed costs like taxes and insurance, and variable costs like tires and gas. Using the expected costs of a particular zip code and a suitable vehicle for the job, FAVR can ensure that employees receive accurate reimbursements. 

Employee A and Employee B would receive similar amounts for their fixed costs, since those are similar, but different amounts for their variable costs, since Employee B drives more. Employee B would still receive more than Employee A, but the difference would be reasonable and fair, unlike under the government mileage rate.

The FAVR reimbursement is an IRS procedure for businesses to accurately reimburse employees. FAVR is designed for companies, not individual tax payers. It is an accountable plan that allows reimbursements to be delivered non-taxed as long as certain rules and guidelines are followed.

In states like California that have expense indemnification clauses, FAVR enables companies to prove that reimbursements are accurate. Employees are not going to be under-reimbursed because the reimbursements track with each employee’s costs, and the company is not going to over-reimburse employees because of that level of accuracy.

Want to be able to look your employees in the eye and stand behind the reimbursement you provide for them? FAVR is the way to go. FAVR has truly become the gold standard for vehicle reimbursement, and it's not even close.

For more information about how a FAVR program works, read our Ultimate Guide to FAVR Reimbursements. You can also try our savings calculator below.

IRS Rate v. FAVR - Calculate Savings

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