As the fourth quarter begins, we near the fourth year in which employees who receive a car allowance cannot write off mileage on their tax returns. This reality combined with rising gas prices, pandemic challenges, and state labor codes means that your organization should review its current car allowance before 2022 arrives.
How the tax code, labor laws, and the pandemic have impacted car allowances
Coinciding with the 2018 tax reform, the state of Illinois added a new clause to its labor code indemnifying employees from business expenses. Illinois joined California, Massachusetts, and six other states in requiring employers to fully reimburse employees for all business expenses, including the costs of a personal vehicle used for work.
Then the Covid-19 pandemic hit, and non-essential employees were forced to work from home. On our annual survey in early 2021, 80% of mobile employees reported negative impacts from changes to business vehicle policies as employers looked to cut costs.
Though many industries have returned to normal, rising gas prices and inflation have added yet another challenge for mobile employees. Unless their employer offers a car allowance responsive to increasing costs, these drivers now find their car allowance worth less than just a year or two ago.
These changes should make you re-think your car allowance policy immediately.
5 reasons to update your car allowance for 2022:
Tax reform effects
Under the current tax code, your employees cannot 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 cannot expect employees to just write off their mileage or the difference between their expenses and their allowance.
State indemnification codes
Illinois is just the beginning. Several states already have employee-friendly labor laws (such as CA, RI, MA, NY, and MI), and others may join them as employees complain about car allowances not keeping up with costs. If your car allowance does not fully reimburse employees, you could have problems as they cannot deduct their business mileage and gas prices and inflation are rising rapidly. Employees in these states can hold the company accountable under their labor code, and that could get costly fast.
Attrition rates due to vehicle costs
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 may look 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. (There are four tell-tale signs to indicate whether your car allowance is competitive.)
Compensation for an expense (instead of reimbursing)
This one may surprise you. 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.
Tax expense on payments of decreasing value
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% to 40%. If you pay $600/month, your employee may be taking home less than $400. With gas prices and inflation increasing, there will likely be a gap between that employee’s business expenses and your car allowance amount. This gap will expose you to all the problems we’ve 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. The same payment sum suddenly becomes worth 40% more to the employee while costing the employer significantly less.
Offering a competitive car allowance in 2022
Now is the time to make changes to your business vehicle policy. The pressure to adhere to CA Labor Code 2802(a) already existed. Then came the pressure 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.
Now vehicle expenses have increased significantly, and the current labor shortages in some industries are giving employees the ability to command more robust compensation. How do you retain strong employees and attract new talent without breaking the bank?
The easiest solution is a non-taxable car allowance.
Now is the time to re-structure your employee car allowance policy. Here's a calculator to determine how much a non-taxable car reimbursement would save compared with your current taxable car allowance: