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.
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.
Many people do not know that the IRS mileage rate is a tax deduction tool for individual taxpayers – not a business reimbursement tool. Using it for mileage reimbursements will over-reimburse high mileage travelers and under-reimburse low mileage travelers.
Using the IRS rate for reimbursements may be effective if all employees incur vehicle costs close to national averages and drive similar mileage amounts. However, when employees cover different regions and territories of varying sizes, these costs and mileage amounts can vary significantly.
What's needed is a customizable rate to deliver accurate, equitable reimbursements. Interested in calculating a free, customized mileage rate? Here's how:
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 it provides a fair estimate that averages out when applied to millions of drivers. However, for individual employees who receive that rate as reimbursement for current expenses, the math often does not work out.
The 2022 gas price spike was unexpected, leading to a rare mid-year adjustment in the IRS mileage rate. This worked fine for people filing their 2022 tax returns the following spring. However, during the spring and summer of 2022, the wide variation between average expected costs and actual experienced costs rendered the IRS rate unreliable for workers.
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 incur costs beyond what their employers actually need for reimbursement.
Let's explore further the issues with using a standard mileage rate for business reimbursements and how to address these in 2024.
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).
Using a standardized mileage rate will not work for both types of drivers. Insufficient reimbursement is actually illegal in California and a few other states due to labor code indemnification. 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.
The reason the IRS mileage rate under-reimburses low-mileage drivers and over-reimburses high-mileage drivers is due to the fixed costs of vehicle ownership. These costs include insurance, license, taxes, and depreciation. An employer should 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 must drive a certain number of miles to recover the fixed costs, plus additional miles to cover the operational costs. Insurance and depreciation alone can account for 60% or more of a vehicle's annual cost.
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, accumulating a significant number of miles at much lower per-mile costs.
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 to changing times, and inaccurate payment amounts.
However, simplicity is crucial, especially when employee expenses fluctuate. No one wants their managers or drivers spending hours trying to calculate individualized reimbursements based on the different driving circumstances of various workers.
One way to achieve simplicity without compromising accuracy and flexibility is to outsource vehicle reimbursements to experts, who can utilize the latest vehicle cost data and technology to effectively personalize and manage reimbursements. There is an alternative IRS-recommended approach: FAVR.
With a FAVR vehicle plan, all employees need to use a mileage app to track their business mileage, and the software handles the rest, providing accurate reimbursement.
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 a little in one month, they still get reimbursed for the fixed costs. If they drive a lot, they are reimbursed accurately, rather than being overpaid. Like the IRS rate, FAVR reimbursement 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.