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?
On July 1, 2022, the IRS business mileage rate increased from 58.5 cents per mile to 62.5 cents/mile. With gas prices at record highs, this mid-year increase made sense. However, that increase did 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 business reimbursements may work if all the employees experience vehicle costs close to national averages and drive similar mileage amounts. But within companies with employees covering different regions and different territory sizes, these costs and mileage amounts will vary significantly. These circumstances require a customizable rate to deliver accurate and equitable reimbursements.
Interested in getting 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.
The previous year's circumstances can differ greatly from the current year's. Gas prices in 2021 were a lot higher than they were in 2020, with high prices expected to continue throughout 2022. But did anyone expect prices to skyrocket from March through July? That's what led to the IRS rate increase. But soon after, average prices decreased from the peak of around $5/gallon to around $3.50/gallon.
This wide variation between average expected costs and actual experienced costs makes the IRS rate unsuitable in most cases as a vehicle reimbursement.
In addition, because the IRS business rate is calculated based on average mileage amounts, drivers outside of the average will not receive accurate reimbursements. 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 2022.
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 driver will experience costs much higher than average. Because that driver covers an urban territory, his or her mileage will be lower than average, even though the hidden costs of driving in stop-and-go traffic will add up.
Using a standardized mileage rate will fall short of the vehicle expense need. Insufficient reimbursement is actually illegal in California and a few other states due to indemnification labor codes.
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 business travel, but also the business portion of the costs of ownership.
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. This company needs a reimbursement approach that takes fixed costs into account regardless of mileage, along with vehicle cost data specific to particular regions.
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 come a lot of problems with 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 for 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.