If your company uses the IRS business mileage rate to reimburse employees, you are using the wrong tool for the task. This vehicle reimbursement approach has significant shortcomings in a normal year, but the unique challenges of 2020 have exposed these shortcomings further. Let's look at three key reasons to avoid mileage reimbursement at the 2020 IRS rate.
What is the 2020 IRS Business Mileage Rate?
The 2020 IRS business mileage rate is 57.5 cents per mile. But there's more to it than that. 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 mileage reimbursement works in certain situations, particularly if all the employees experience similar geographic costs and drive similar mileage amounts. But often drivers experience very different costs and accrue different mileage amounts, especially within companies with employees covering different regions and different territory sizes. Under these circumstances, you need a customizable rate to deliver accurate and equitable reimbursements.
How was the 2020 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. The previous year's circumstances can differ greatly from the current year's. Gas prices in 2019 were a lot higher than they have been so far in 2020, but drivers have also been working from home a lot more and therefore driven a lot less.
It is this wide variation between average expected costs and actual experienced costs that makes the IRS rate unsuitable in most cases as a vehicle reimbursement. With different parts of the U.S. reopening from lockdowns at different rates, and with the possibility that some regions will reinstitute travel restrictions as new COVID-19 outbreaks occur in the future, organizations paying mileage reimbursements need a much more flexible approach to offset employees' vehicle costs.
3 key needs for 2020 vehicle reimbursement rates
Let's explore further the problems with using a standard mileage rate for business reimbursements and how to address these in 2020.
1. Flexibility – the 2020 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.
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. Similarly, if a virus outbreak occurs in California that forces non-essential workers off the roads again, but Arkansas remains open for business, then the inequity will widen.
Some vehicle reimbursement is still owed to the CA employee because the company expects that employee to maintain his or her vehicle and keep the insurance current so the vehicle is available when remote work is no longer necessary.
2. Accuracy – only a data-driven reimbursement rate will work in 2020
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. Because the employer requires the employee to use a personal vehicle for work, the 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, and then an additional number of miles to recover the operational costs. And typically insurance and depreciation account for 60% of the annual cost of a vehicle. In a state like Michigan, which has very high auto insurance rates, that percentage could be even higher.
For drivers with small, expensive territories and drivers forced to work temporarily from home, a mileage-based reimbursement will not accurately cover costs. The same employer could simultaneously be overpaying an employee with a large but inexpensive driving territory, racking up lots of miles with much lower per-mile costs. This company instead 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, all the employees would have to do is use a mileage tracking app to record their business mileage, and third-party software would do the rest in supplying their accurate reimbursement.
Flexibility, accuracy, and simplicity for vehicle reimbursements
To achieve the three key needs of 2020 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 the fixed costs of ownership and the mileage-based costs.
If the employee barely drives one month, that employee still gets reimbursed for the fixed costs. If the employee drives a lot in that month, the employee gets reimbursed accurately rather than overpaid. Like the IRS rate, this reimbursement approach is tax free. Implementing an IRS accountable plan that was designed for business vehicle reimbursements instead of for personal tax deductions is the way to go.
If you are looking for alternatives to the 2020 IRS mileage rate or tools to help you better manage reimbursement costs and productivity contact mBurse today for a free evaluation.