For employees who drive a vehicle as part of the job, a mileage reimbursement is a key way to offset expenses. But what does a mileage reimbursement include? How do you know if your mileage rate is fair?
A mileage reimbursement uses a cents-per-mile rate to calculate the cost of using a vehicle for work. The most common mileage rate in the United States is the standard business rate published annually by the IRS. This federal rate or "safe harbor rate" is viewed as the gold standard and a reasonable and fair way to reimburse employee vehicle expenses.
The 2023 rate of 65.5 cents per mile is designed to cover a range of costs associated both with owning and operating a vehicle used for business. This rate is calculated each year based on the average costs of owning and operating a vehicle driven an average number of miles annually. This means that the rate is most accurate for drivers who experience average costs.
Some organizations develop their own mileage rate that they consider more suitable for their particular employees. As long as their rate remains at or below the IRS business rate, then the payments are tax free. It is also possible for a business to pay different mileage rates to employees based on location or to pay a base stipend with a mileage rate on top of it (this is called a FAVR reimbursement).
Fuel is the most obvious expense associated with operating a vehicle for work purposes. So a mileage rate has to account for fuel costs. Two challenges that come with this are the variations in fuel prices based on time and location and the variations in fuel efficiency between different vehicles.
If the highs and lows of gas prices over the course of the year even out, then it is not a problem for the mileage rate. But if they spike or plummet, then your organization should consider responding with an adjustment to the mileage rate. There is also the problem of a driver based in a state with expensive fuel prices like California versus a driver based in a less expensive state like South Carolina or Texas.
A mileage reimbursement should be able to cover an employee's car insurance, or at least the business-related portion of it. You can calculate the business portion by the percentage of time or mileage spent on work responsibilities. Many employers require a minimum level of insurance coverage to protect both the employee and the organization from lawsuits in the event of an accident.
Using a mileage rate to reimburse insurance coverage can create a mismatch, however. Because a vehicle's monthly mileage is a small factor in the insurance rate but the determining factor in the mileage reimbursement, it is possible for a low-mileage driver to receive an insufficient reimbursement to cover insurance and other fixed monthly costs. That is why some organizations pay a monthly stipend that covers the known insurance premium and factor it out of the mileage rate.
Other obvious expenses are tires, oil, and maintenance. The more a person drives, the more often that driver must replace tires, change oil, and complete other routine maintenance. A mileage rate, because it calculates payments based on how much you drive, is well-suited to reimburse these expenses.
Other less obvious expenses include taxes, license, registration, and depreciation. As with insurance, these ownership-related expenses should be reimbursed in proportion to the time spent using the vehicle for work. But also like insurance, these costs are either entirely or mostly independent of how much a person drives. They are tied more to the age, size, and value of the vehicle. Once again, low-mileage drivers may not drive enough to offset these costs with a mileage rate.
A fair mileage reimbursement rate is accurate or nearly accurate for all the employees in the organization who are reimbursed for mileage. This is easier said than done.
The IRS standard business rate (65.5 cents-per-mile for 2023) is fairly accurate if an employee drives an average number of miles per year and works in a location with average costs. But low-mileage and high-mileage drivers, as well as drivers in very expensive locations may not find it a suitable rate.
The same would be true for any standardized mileage rate unless your organization is local or regional and is able to determine a rate that is fair for its workers within that locality or region. If there are major discrepancies between the amount of driving between different employees or there are employees spread out across the country, calculating a fair mileage rate gets complicated.
An organization can opt to review its mileage rate periodically to make sure it reflects current gas prices as they rise and fall. It can also place employees in tiers based on how much they drive and/or how expensive their location is. The different tiers are then reimbursed at different rates. All these reimbursements remain tax-free if they do not exceed the IRS business rate.
The problem of fixed ownership costs like auto insurance and depreciation still remains. This is why some organizations use the FAVR reimbursement method ("fixed and variable rate"), which reimburses those costs separately from the mileage rate.
If your organization's mileage rate does not seem to be keeping up with expenses or seems to create unfair discrepancies between employees, it may be worth exploring one of these alternate options. Contact mBurse to learn more about which option would best fit your organization.
Or select the button below to try our 3-step process for calculating a fair and accurate reimbursement rate for your organization.