An IRS-approved, tax-free plan, the fixed and variable rate (FAVR) allowance reimburses employee vehicle expenses accurately and equitably. Leveraging data to reimburse auto expenses, FAVR is more precise and transparent than any other vehicle reimbursement plan.
If you’ve spent any time on the mBurse website, you’ll know that we promote fixed and variable rate reimbursement (FAVR) as the preferred way to address employee vehicle expenses. The following Q & A answers common questions about this best practice approach to auto reimbursements.
What is a tax-free FAVR reimbursement plan?
A FAVR reimbursement plan combines a fixed monthly car allowance with a variable mileage rate, both paid tax-free. The IRS has recognized FAVR as an accountable vehicle reimbursement procedure since 1992. A FAVR vehicle plan differs from a traditional car allowance in two important ways:
- All payments are non-taxable.
- Rates vary based on localized expense data.
A FAVR plan also differs from a standard mileage reimbursement plan. Rather than paying a set, one-size-fits-all mileage rate like the IRS rate, a FAVR plan meets each driver's expense needs equitably. This makes sense because expenses vary greatly by region and by how much an employee drives.
FAVR was specifically designed for corporations to use for proper reimbursement of employees, whereas the IRS mileage rate was designed for use by individual taxpayers seeking to deduct business mileage. This reimbursement policy is considered to be best practice.
If you are interested to know how much money your organization could save by switching away from a mileage rate or car allowance to a FAVR plan, use this calculator:
How does a FAVR reimbursement plan work?
First, an organization selects a standard vehicle to be used to generate the car reimbursement rates. This vehicle is based on what the employees need to carry out their jobs, not what they actually drive – a business class vehicle that would be considered fair to base everyone's reimbursements on, as opposed to basing rates on personal vehicle choices.
[Read more: How Reimbursement Using a Standard Vehicle Works]
Next, a fixed allowance and a mileage rate for each employee is calculated based on
- Their home zip code or garaging point
- The standard vehicle chosen by the company
Each employee then receives a vehicle reimbursement schedule that details all of the costs being they are being reimbursed with their allowance and mileage rate. These costs are broken into two major categories: fixed costs and variable costs. A typical schedule covers the following expenses:
Fixed costs, addressed by the fixed monthly car allowance:
- Insurance
- License fees
- Vehicle taxes (if applicable)
- Registration
- Depreciation
Variable costs, addressed by the cents-per-mile rate that adjusts each month to keep up with gas prices:
- Gas
- Oil
- Maintenance
- Tires
Because the rates are transparent, scalable, and accurate, they comply with employee-friendly states that have expense indemnification codes. This benefit is particularly important for organizations with employees operating in California and Massachusetts.
What IRS tax guidelines govern FAVR plans?
The IRS has issued a set of requirements that define FAVR and delineate it as a non-taxable, or accountable, auto reimbursement plan. The vast majority of the rules are based on data modeling. Some of the better-known rules govern:
- Vehicle value
- Vehicle age
- Insurance requirements
- Annual business mileage
- Business use percentage
- Control employees participation
Quite a few people do not know that some of the FAVR requirements are based on the company’s objectives. For example, if a company would like to control their image they can use nicer or newer vehicles to generate the reimbursement rates. This in turn would require employees to utilize nicer or newer vehicles. FAVR programs are customizable to company objectives.
How are FAVR vehicle plans administered?
Because FAVR regulations involve complex calculations and change annually, it is best to have a third-party administrator design, implement, and manage your program as opposed to self-administering. A trusted advisor that stays ahead of the rulings and has experience with administration can prove indispensable.
An analogy: No one tries to administer their own health care benefits. It could be done, but it would tie up valuable time and resources when it is much easier to find a benefit broker.
Switching from a traditional car allowance to a FAVR plan frees up significant financial resources by eliminating tax waste. This allows an organization to improve employee benefits and reduce overall expenses all while paying a third-party administrator.
Similarly, switching from the IRS mileage rate frees up resources by eliminating overpayments to high-mileage employees and reducing attrition due to the underpayment of low-mileage employees.
Why should businesses choose a FAVR plan?
Fixed and variable rate programs were designed specifically to determine auto reimbursements accurately, equitably, and easily. An organization is able to reimburse employees exactly the same way they incur costs, based on where they live and drive.
FAVR reimbursement plans make sense because they will not over or under-reimburse employees. They also
- Control company costs
- Mitigate risks (from labor codes and general liability)
- Help attract and retain talent
With the changes to the tax code from the 2017 reform, it is more important than ever to stop paying a flat taxable car allowance or over-reimbursing using the IRS mileage rate. The new law eliminated the unreimbursed business expense deduction. Consequently, employees now expect more robust vehicle reimbursements.
The company should be looking for a vehicle reimbursement that is accurate for each employee while controlling costs, something that is not easy. Remember there are states where employees can sue for unreimbursed business expenses.
Switching to a tax-free FAVR reimbursement plan
Whether you use a car allowance or a mileage reimbursement or some combination, you will face challenging questions:
- Are you over-reimbursing some while under-reimbursing others?
- Are you and your employees losing money to unnecessary taxation?
- Are all of your employees happy with their allowance or reimbursement?
- Are you able to control reimbursement costs and stay within budget?
- Are you inadvertently violating state labor laws?
FAVR resolves these quandaries and simplifies reimbursement of employees for the business use of a personal vehicle.
Switching to a FAVR program can be communicated to employees in simple and convincing ways when implemented so that everyone in the company understands how the switch will benefit them.
mBurse specializes in helping organizations adopt and implement FAVR programs. Find out how your organization and its employees could benefit today.
