Congress passed a massive tax reform for tax years 2018-2025. If your company pays a taxable car allowance, it's time to consider a non-taxable plan.
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.
It is also important to know that through 2017 employees who drive for work could deduct their business mileage. This allowed them to recoup much of the taxes withheld from their car allowance. However, because of a rule change, these employees are hit pretty hard by the Tax Cut and Jobs Act. This forces everyone to rethink what counts as a fair car reimbursement.
Changes to how car allowances are taxed
Under the new plan, most Americans see some reduction in taxes. How much depends on factors such as whether they have children and whether they itemize deductions. An employee with children who took the standard deduction in 2017 might have seen a significant decrease in taxes in 2018. A person with no dependents and who itemizes might have seen only a small decrease, or even an increase if they face high state, local, and property taxes (due to a new cap on that deduction).
Most important for employees who receive a vehicle allowance, a person who previously deducted business expenses such as mileage essentially faced a tax increase. This is due to the elimination of the miscellaneous expense deduction, which impacts many employees who use a personal vehicle for work.
Overall, many mobile employees are seeing more of their monthly car allowance protected from withholding. But without the mileage deduction, a taxable vehicle allowance could be more costly for both employees and employers.
The fact is, the new tax code does not address the underlying problems with taxable car allowances. In the long run, while corporations will see a huge tax break (from a 35% rate down to a 21% rate), the fundamentals will not change for mobile employees, and the tax breaks for individuals will expire after 2025.
3 vehicle allowance problems the new tax law cannot address
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 25% and 39.6% in taxes on that allowance. In other words, out of a $500/month allowance, those employees take home only somewhere between $375 to $302. The 2018 tax tables shift those brackets down to a range of 22% to 37%, leaving those same employees to take home $390 to $335 of a $500 allowance. While the increased standard deduction and increased child tax credit may give some employees an additional boost, taxes still eat up a large chunk of the car allowance.
Car allowances don't keep up with changing employee costs.
The 2018 mBurse car allowance survey found that 73% of companies have not changed their car allowance amount in the last ten years. During that same period, inflation rose 14.5%, according to The Bureau of Labor Statistics. That means that a $500/month allowance in 2007 is worth only $426 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.
Any boost from the new tax bill is just playing catch-up with an unchanged car allowance. Plus, in losing the ability to deduct unreimbursed expenses, employees now have no way to offset rising costs. (Update: our 2019 Car Allowance Survey found that 79% of companies still have not adjusted to the new tax realities.)
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. Nor can regional companies escape differences in expenses. Some employees cover larger territories than others. Just as the tax cuts will help some more than others, a standard monthly vehicle allowance may help some employees and shortchange others.
The new tax cuts may provide a temporary boost to some employees, but it won’t fix the long-term problems. 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.
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 $500/month allowance, and on average $130 of that goes to taxes, you’re essentially paying the IRS $2,600/month that really is intended to meet employees’ expenses. Plus, you’re paying $38/month in payroll taxes on each $500 allowance. That’s a total of $3,360/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.
Yes, going to a non-taxable reimbursement adds new processes and administrative tasks—but that’s not as big of a deal as it sounds. 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.