3 Reasons Taxable Car Allowances Don't Make Sense after Tax Reform

Written by mBurse Team Member Aug 30, 2021 7:00:00 AM

In 2017 Congress passed a massive tax reform for the years 2018-2025. Under the rules of these tax years, paying a taxable car allowance just isn't worth it.

When is a car allowance taxable?

By law, vehicle allowances paid to employees should be taxed unless the employer follows a procedure to prove business use of vehicle expenses. If your organization provides a flat, monthly sum in payment for employee vehicle costs, then that allowance is taxable income.

For many years employees who drove for work could deduct their business mileage. This allowed them to recoup much of the taxes withheld from their car allowance. However, these employees were hit pretty hard by the Tax Cut and Jobs Act, which removed that deduction. Some employers switched to non-taxable plans as a result, but most did not, as our 2019 survey found.

Changes to how car allowances are taxed

Employees who received a taxable vehicle allowance essentially faced a tax increase in 2018. This is due to the elimination of the miscellaneous expense deduction. Unless their employer made changes to their allowance or car reimbursement approach, these employees have had to absorb what felt like a pay cut – if they stuck with that employer.

While overall the 2017 tax reform and tax reforms since then, such as the expanded Child Tax Credit in 2021, put a lot of money back in the pockets of the American people, the same cannot be said for employees who used to count on deducting work-related expenses (unless they have a lot of kids!).

The fact is, the current tax code exacerbates existing problems with taxable car allowances. It simply does not make sense for employers to continue paying taxable car allowances. Here are three reasons why.

3 reasons taxable car allowances need reforming

  1. The biggest problem with taxed car allowances is taxes.

Mobile employees receiving a taxable car allowance lose a huge chunk to taxes. Most employees pay somewhere between 22% and 37% in federal income taxes on that allowance. Then add in FICA and state income taxes, if applicable, for a total tax burden of anywhere from 30% to 45%. In other words, out of a $600/month allowance, an employee might take home only $350.

Think about it – if you pay a taxable car allowance, one third or more of that money is just going to the government, not actually to your employee. Does that make sense?

  1. Car allowances don't keep up with changing employee costs.

Over the years, our surveys have found that companies will often go a decade or more between changes to their car allowance amount. According to the inflation calculator at The Bureau of Labor Statistics, a $600/month allowance from 2011 is worth only $496 in today’s dollars. Other expenses like gas prices, car insurance rates, registration fees, and personal property taxes fluctuate over time. Insurance premiums in particular have risen significantly over the past ten years.

This means that a car allowance should be adjusted regularly to reflect today's costs, not yesterday's.

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  1. Taxable vehicle allowances do not address differences in employee needs.

Most organizations pay the same monthly amount to all employees. But different locations come with different expenses. Take a look at the GasBuddy price map. Prices run a lot higher in California, Washington, and Michigan than they do in Texas, Arkansas, and South Carolina. Maintenance costs and insurance rates also differ by state.

Some employees cover larger territories than others. A standard monthly vehicle allowance may help some employees and shortchange others. Employees whose car allowance does not fully cover expenses may become less productive, seek work elsewhere, or, in some states, sue the company for a labor code violation. It’s time to find a better way.

Car allowance and labor code violations

Non-taxable vehicle reimbursement – better than a tax cut

Now is a great time to consider transitioning from a taxable car allowance to a non-taxable vehicle reimbursement plan. Employees will see a net increase in monthly pay, and the company will save money. Plus, a reimbursement can be tailored to address the different needs of different employees and address any deficits from the eliminated unreimbursed expense deduction. 

Do the math. If you pay 20 employees a $600/month allowance, and on average $240 of that goes to taxes, you’re essentially paying the IRS $4,800/month that really is intended to meet employees’ expenses. Plus, you’re paying $40.50/month in payroll taxes on each $600 allowance. That’s a total of $5,610/month in tax waste!

A non-taxable plan will allow you to split that money between employees and the organization, depending on the employees’ actual needs. The employees get a bigger boost than they ever could from a tax cut, and the company saves money.

A non-taxable reimbursement adds new processes and administrative tasks, but mBurse can provide all the administrative and technological support you need to make the shift. Contact us today to find out how to switch to a FAVR or non-taxable plan as painlessly as possible.

Car allowance vs. FAVR Reimbursement

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