Businesses that use the IRS mileage rate to reimburse employees are using the wrong tool for the task. Let's look at three key reasons to avoid mileage reimbursement at the IRS business rate.
Why does the IRS business rate deliver incorrect reimbursements?
As of January 1, 2024, the IRS business mileage rate is increasing from 65.5 to 67 cents/mile. With vehicle costs higher than ever, the increase makes sense. However, the increase does not address the fundamental problems with using the rate for employee reimbursements.
Using the IRS rate for reimbursements may work if all employees experience vehicle costs close to national averages and drive similar mileage amounts. But when employees cover different regions and territory sizes, these costs and mileage amounts will vary greatly. What's needed is a customizable rate to deliver accurate, equitable reimbursements.
Interested in calculating a free, customized mileage rate? Here's how:
How is the IRS mileage rate calculated?
The IRS mileage rate in any given year is derived from the average costs of vehicle ownership and operation for the previous year across the entire United States – calculated based on average mileage amounts.
This approach works well for tax deductions because what is needed is a fair estimate that averages out when applied to millions of self-employed individuals who drive a vehicle for work purposes. It also works as an after-the-fact tax deduction tool. But for employees receiving that rate as a reimbursement for current expenses, the math often does not work out.
The gas prices spike of 2022 was unexpected, leading to a rare mid-year adjustment in the IRS mileage rate. This worked just fine for people filing their 2022 tax returns the following spring. But during the spring and summer of 2022, this wide variation between average expected costs and actual experienced costs made the IRS rate unreliable.
Even in a normal year low-mileage drivers often find that their fixed vehicle expenses (insurance, depreciation, taxes) exceed their reimbursement amount. At the same time, high-mileage drivers often cost their employers beyond what they actually need for reimbursement.
3 key needs for vehicle reimbursement rates
Let's explore further the problems with using a standard mileage rate for business reimbursements and how to address these in 2024.
1. Flexibility – the IRS mileage rate is too standardized
An urban driver in California will experience different vehicle costs than a rural driver in Arkansas. That California urban driver will experience higher costs than average. An urban territory can mean lower mileage than average, with higher costs per mile (especially with stop-and-go driving).
If the same company employs both the California driver and the Arkansas driver, the company needs to pay them different rates to avoid inequitable reimbursements.
2. Accuracy – a data-driven reimbursement rate is best
The reason the IRS mileage rate under-reimburses low-mileage drivers and over-reimburses high-mileage drivers has to do with the fixed costs of vehicle ownership. These costs include insurance, license, taxes, and depreciation. An employer is obligated to offset not only the mileage-based costs of travel, but also the business portion of ownership costs.
When a reimbursement is based entirely on mileage, an employee has to drive a certain number of miles to recover these fixed costs, plus additional miles to recover the operational costs. Typically, insurance and depreciation account for 60% of the annual cost of a vehicle. In a state like Michigan, which has high auto insurance rates, that percentage could be even higher.
For drivers with small, expensive territories a mileage-based reimbursement will not cover costs. The same employer may also be overpaying an employee with a large but inexpensive territory, racking up lots of miles with much lower per-mile costs.
3. Simplicity – the only positive of the IRS mileage rate
When businesses choose to reimburse using a mileage rate, they do it for the simplicity of the system. However, with that simplicity comes inequities between employee reimbursements, inability to adjust with changing times, and inaccurate payment amounts.
But simplicity is important, especially when the expense needs of employees keep fluctuating. No one wants their managers or drivers spending hours trying to calculate individualized reimbursements based on different workers' driving circumstances.
One way to attain simplicity without sacrificing accuracy and flexibility is to outsource vehicle reimbursements to the experts and let them use the latest vehicle cost data and technology to customize and administer vehicle reimbursements. Under this system, known as a FAVR vehicle plan, all employees have to do is use a mileage app to track their business mileage, and software does the rest in supplying their accurate reimbursement.
Flexibility, accuracy, and simplicity for vehicle reimbursements
To achieve the three key needs of today's vehicle reimbursements, the process is straightforward. You start by choosing a standardized vehicle instead of a standardized rate to determine reimbursements. A third-party partner uses current data for that standard vehicle to derive localized rates for each employee, including both fixed costs and mileage-based costs.
If the employee drives little one month, that employee still gets reimbursed for the fixed costs. If the employee drives a lot, they get reimbursed accurately rather than overpaid. Like the IRS rate, this reimbursement approach is tax free. Implementing an IRS accountable plan designed for business vehicle reimbursements instead of tax deductions is the way to go.
If you are looking for alternatives to the IRS mileage rate or tools to help you better manage reimbursement costs and productivity, contact mBurse today for a free evaluation.