The IRS mileage rate was designed to be a tax deduction tool for individual taxpayers, but it has become the standard rate for business vehicle reimbursements. The results are costlier than you think.
The IRS business mileage rate remains one of the most popular ways to reimburse employees for business use of a vehicle. It’s easy to calculate at 56 cents per mile (for 2021). However, with that ease comes hidden costs.
The IRS mileage rate, also known as the federal "safe harbor rate," is not the best way to deliver auto reimbursements. Why? For three glaring reasons:
The IRS mileage rate cannot deliver accurate vehicle reimbursements.
In a nutshell, the IRS rate over-reimburses high-mileage travelers and under-reimburses low-mileage travelers. These inequitable results can lead to employee dissatisfaction as well as uncontrollable costs if you employ a lot of high-mileage drivers.
Each employee experiences different costs, so how can only one rate reimburse all employees fairly? The IRS mileage rate has been held as the gold standard for auto reimbursement, but it proves inaccurate time and again. Here are three of the six components for calculating the IRS mileage rate:
- An average of last year’s gas prices
- Costs based on 14,000 total miles
- An average of last year’s insurance costs
The other three cost variables also move the calculations even further from being accurate. Because some employees live in areas with above average gas prices and above average insurance costs, it’s actually possible that the IRS rate may fall short of their expense needs, especially if they are not a high-mileage driver.
The biggest disparity arises because of fixed costs like depreciation, insurance, taxes, and registration. These will likely be similar for two drivers who work in the same part of the country, but if one driver travels a lot more than another, his fixed expenses are a much smaller percentage of his overall vehicle expenses. This is why low mileage drivers often experience the IRS rate as an insufficient auto reimbursement.
The lesson? Drive more, earn more—which leads to the second fatal flaw in using the IRS mileage rate for auto reimbursements.
The IRS mileage rate promotes excessive driving.
Cost control poses one of the biggest challenges effective organizations must face. The IRS mileage rate encourages “driving for dollars”—that is, the company’s dollars. If you pay the IRS rate as an auto reimbursement, you render your costs dependent on two factors—an inaccurate rate (which you can’t control), and on employees’ mileage reporting (which is hard to control). When determining factors of business expenses lie outside your control, problems will arise.
Let’s consider the factor of employee-reported mileage. When providing an unquantifiable mileage rate, it is unreasonable to expect your employees to accept and quantify the rate. When employees experience gas price increases within their driving territories yet the mileage rate remains the same, they will take matters in their own hands. Here’s how:
- Overstating mileage
- Rounding mileage
- Outright fabricating trips/mileage
No one wants to suspect their employees of dishonesty. But is it right to position employees to have to choose between acting with integrity and covering cost deficits? In the end, many employees will act in their self-interest. That’s reality.
The only way to manage the inaccuracies with rate calculations and re-take control of your costs is to use an accurate rate based on actual real time costs.
3. The IRS mileage rate conflicts with state labor codes and the tax code.
The IRS mileage rate has long been the standard for states like California, Massachusetts, South Dakota, North Dakota, and Rhode Island to measure their employee expense indemnification labor codes. But with the December 2017 tax reform, more employees will be looking to prove that the IRS rate doesn’t actually cover all their expenses. Here’s why:
Under the new tax code, individuals cannot write off unreimbursed business expenses. For low mileage drivers, there’s a gap between their expenses and what the IRS rate pays. These employees who now cannot use a tax deduction to offset that gap, may look for recourse under indemnification labor codes. If you have employees working in employee-friendly states, it is more crucial than ever to pay a rate you can quantify, unlike the IRS rate.
There are alternatives to the IRS mileage rate that will properly reimburse all of your employees, control costs, and adhere to labor codes in employee-friendly states.
The only thing that is good about using the IRS mileage rate as a vehicle reimbursement is that it is easy. It’s also easy to lose control of costs and to create dissatisfied employees. Take control of your costs, and evaluate your car reimbursement policy today.