Your company's car allowance covers a wide range of employee vehicle expenses. But what is a car allowance supposed to cover? If you have not adjusted the allowance amount in the past three years, don't be surprised if employee retention has dropped.
Quick Answer: What Does a Car Allowance Cover?
A car allowance is usually meant to help cover the cost of using a personal vehicle for work. It may help pay for fixed costs, such as insurance, depreciation, registration, taxes, and license fees, as well as variable costs, such as fuel, maintenance, oil, and tires.
However, a flat car allowance does not always fully cover each employee’s business vehicle costs. The amount may be taxable, may not adjust for mileage or location, and may underpay high-cost or low-mileage drivers if it is not tied to business use and documented expenses.
Is your company car allowance enough?
The employees who receive a car allowance typically work in sales and service roles and therefore interface with your clients and prospects daily. They are the face of your organization. But what is an auto allowance? It’s a set monthly payment meant to help employees cover the costs of using their personal vehicle for work. However, maintaining a productive mobile workforce can be challenging. It is vital to ensure that your company car allowance is enough to meet these employees' needs.
Since 2020, inflation has increased by 21%. Vehicle costs have been particularly sensitive. Not only have the prices of new and used vehicles risen significantly, but so have auto insurance premiums and maintenance and repair costs. (Insurance premiums have increased by around 20% from 2023 to 2024 alone!) If your organization has not increased its car allowance in the past three years, it is likely too low.
What Does a Car Allowance Usually Cover?
A car allowance, also called an auto allowance or vehicle stipend, is a fixed amount an employer pays to help employees cover the cost of using a personal vehicle for work.
A fair car allowance should consider the business-use portion of both ownership and operating costs. Ownership costs are expenses that exist whether the employee drives many miles or only a few. Operating costs increase as the employee drives more business miles.
Common car allowance expenses include:
- Auto insurance
- Depreciation
- Registration
- Taxes
- License fees
- Fuel
- Maintenance
- Oil
- Tires
- Tolls and parking, if the company policy includes them
Standard car allowances vs. employees' business vehicle costs
Companies that operate in multiple states will almost always find cost variations among employees. This is to be expected. Gas costs around $5 per gallon in California but around $3 in Kansas. Some drivers might cover larger territories than others.
A car allowance that is high enough for one employee might not be enough for another. In determining whether your allowance amount is sufficient, it can be helpful to see whether a) there's a higher employee attrition rate in certain geographic locations than others and b) there are more complaints coming from high-mileage drivers or drivers in expensive areas.
Is your car allowance increasing attrition rates?
Few employees will stay content with a job that does not compensate them fairly. A car allowance that fails to adequately compensate mobile employees will lead to high attrition rates. It’s plain and simple: you have to pay close attention to whether your auto reimbursement policy is helping to retain employees or driving them away. Here's the formula:
Standard Car Allowance + Dynamic Vehicle Costs = Employee Attrition
A fair car allowance should cover ALL reasonable costs associated with owning and operating a vehicle for work. The problem is that vehicle costs change over time, and different employees incur different costs.
If you have not updated your policy recently, or if you are providing a standard car allowance amount for all employees regardless of territory costs or size, it is probably contributing to your retention problems. There's a good chance you have many employees with unmet driving costs.
Our annual survey found that 79% of mobile employees rated their car allowance or reimbursement amount as very important in their employment decisions. At the same time, 60% of responding companies paid less than $600/month. After taxes, that amount could be $400 or less.
One first step in determining the right allowance amount for your company is to use benchmarking data. Finding out what similarly sized organizations and businesses in your industry pay can help you determine a fair allowance amount.
Is a Car Allowance Taxable?
A standard car allowance is often taxable when it is paid as a flat amount through payroll without mileage substantiation or accountable-plan controls. In that case, the allowance may be treated more like compensation than a tax-free reimbursement.
Employers that want tax-free treatment generally need to connect payments to documented business use, require timely records, and handle excess payments correctly under accountable-plan rules.
This matters because a taxable allowance may not provide the employee with the full amount the employer intended. For example, a $600 monthly allowance may be reduced by payroll taxes and withholding before the employee uses it for vehicle costs.
What Is a Better Alternative to a Flat Car Allowance?
A flat car allowance can be simple, but it may not match each employee’s actual business vehicle costs. Employees in different locations, territories, or mileage bands may have very different fuel, insurance, maintenance, depreciation, and registration costs.
FAVR, or Fixed and Variable Rate reimbursement, separates fixed vehicle costs from variable operating costs. Fixed costs may include insurance, depreciation, registration, taxes, and license fees. Variable costs may include fuel, oil, tires, and maintenance.
Because FAVR can account for mileage, location, and vehicle cost assumptions, it may provide a more accurate reimbursement structure than a flat monthly allowance. FAVR can also support tax-free reimbursement when IRS requirements are met, and business mileage is properly documented.
The costs of an insufficient vehicle reimbursement
The first step in the employee's departure from the company will be modifying their behavior to reduce costs. This, in turn, costs the company, as employees opt for phone or video calls instead of business travel.
If the employee leaves your company, you face a new set of costs. Recruiting, hiring, and training employees takes time and money. It takes, on average, 42 days and $4,129 to fill an open position.
Employees are not going to continue working a job that does not protect their income from the costs of operating their vehicle. Make sure your organization does not make the mistake of providing a standard, equal car allowance for all employees regardless of their territory size or costs. Equal is not the same as equitable.
Mobile employees trust your organization to properly reimburse them for business use of their vehicles. If their car allowance does not cover the full range of vehicle expenses, why shouldn't they do something about it?
FAQs About What a Car Allowance Covers
What does a car allowance usually cover?
A car allowance is usually meant to help cover the cost of using a personal vehicle for work. It may help pay for insurance, depreciation, registration, taxes, license fees, fuel, maintenance, oil, tires, tolls, and parking, depending on company policy.
Does a car allowance cover gas?
Yes, a car allowance often helps cover fuel costs. However, because fuel costs change by mileage, location, and market prices, a flat allowance may not fully reflect each employee’s actual business fuel expense.
Does a car allowance cover insurance?
A car allowance may help offset the business-use portion of auto insurance, but a flat payment may not fully reflect each employee’s actual premium, coverage level, or business-use exposure.
Is a car allowance taxable?
A standard car allowance is often taxable when it is paid as a flat amount through payroll without mileage substantiation or accountable-plan controls. Employers that want tax-free treatment generally need to connect payments to documented business use.
What expenses are not always covered by a car allowance?
Tolls, parking, ferry costs, repairs, high insurance premiums, and depreciation may not be fully covered unless the employer’s policy specifically accounts for them or reimburses them separately.
Is FAVR better than a car allowance?
FAVR may be a better fit for employers with frequent drivers, different territories, or different mileage levels. It separates fixed and variable vehicle costs and can create a more cost-specific reimbursement structure than a flat monthly allowance.
Choosing a Better Vehicle Reimbursement Strategy
A flat car allowance may be simple, but it does not always account for taxes, mileage, territory size, fuel costs, insurance, depreciation, maintenance, tolls, and parking. Employers should regularly review whether their allowance still reflects the true cost of business driving.
A more accurate reimbursement strategy should define which vehicle costs are covered, how business use is documented, whether payments are taxable, and whether employees in different territories need different reimbursement amounts.
Not sure whether your car allowance is covering the right vehicle expenses? mBurse can help you compare taxable allowances, mileage reimbursement, and FAVR to identify where your program may be underpaying, overpaying, or creating unnecessary tax waste.
