This spring, taxpayers will file under the new tax code for the first time. Changes in the rules governing miscellaneous deductions will affect thousands of workers who receive a taxable car allowance.
Coinciding with the 2018 tax reform, the state of Illinois has now added a new clause to its labor code indemnifying employees from business expenses. As of January 1, organizations operating within the state of Illinois have 30 days to ensure they are properly reimbursing employees under the Illinois Wage and Payment Collection Act.
Tax reform will affect all companies operating in the U.S., but so might the labor law changes in Illinois—eventually. We’ll explain why below.
These two changes, along with three other important issues, should make you re-think your car allowance policy immediately. (Number 4 may surprise you!)
Here are the top five reasons you need to address your car allowance today:
- Because you should: Tax reform
As a result of changes in the tax code, your employees can no longer write off unreimbursed business expenses until 2026. If your employees receive a car allowance, they cannot deduct mileage anymore. This means it’s up to your organization to provide a full car reimbursement. You can no longer expect employees to just write off their mileage or the difference between their expenses and their allowance.
- Because it’s the law: State indemnification codes
Tax reform may push more states to dictate proper reimbursement of employees. Illinois is just the beginning. Several states already have employee-friendly labor laws (CA, RI, MA, NY, and MI), and others may now join them. If your car allowance does not fully reimburse employees, you could have problems now that they cannot deduct their business mileage. Employees in these states can hold the company accountable under their labor code, and that could get costly fast.
- Because you need to: Attrition rates
Your employee car allowance either helps you or hurts you in attracting and retaining top talent. If your organization doesn’t reimburse employees properly, your employees are going to consider looking for work elsewhere. Losing experienced employees can get expensive in both the loss of revenue from reduced productivity and the costs of finding and training new employees.
- Because it makes sense: Compensation for an expense
If your organization pays a 401K match, you are paying a match on a business expense (the car allowance). Does that make sense? The IRS considers a car allowance taxable income rather than a reimbursement for business expenses. This means you are also paying payroll taxes (FICA/Medicare) on the car allowance (taxable income). Switching to a properly executed, non-taxable car reimbursement will end these unnecessary payments.
- Because it’s the right thing to do: Tax attack!
Tax waste is the Achilles heel of car allowances. Federal taxes, state taxes (if applicable), and FICA/Medicare eat into your employees’ allowance, often by 30% or more. If you intended to pay $600/month, your employee might only be taking home around $400. In today’s economy, there will likely be a gap between that employee’s business expenses and your car “reimbursement.” This gap will expose you to all the problems we’ve already covered. But there’s a chance that, by switching to a non-taxable car reimbursement, you won’t have to increase your employee car allowance amount. Converting that employee tax waste might actually cover any increases to their take-home pay.
Now is the time to make changes to your business vehicle policy before it’s too late. The pressure to adhere to CA Labor Code 2802(a) already existed. And now there are pressures from the Illinois Wage and Payment Collection Act, which requires employers to “reimburse an employee for all necessary expenditures” they incur for completing the duties of their job. Employers in Illinois have until February 1 to get this right—30 days after the law goes into effect.
Another looming deadline is April 15. As employees file 2018 income taxes in advance of that date, they will discover that the business expense deduction they relied on in the past has disappeared. They won’t be happy, and they may look for recourse.
Now is the time to get ahead of these deadlines and re-structure your employee car allowance policy. Remove any gaps between employee expenses and what the allowance pays—and cut unnecessary tax waste in the process.