You don’t have to overpay to reimburse your employees – unless, that is, you’re paying the IRS standard mileage rate. With ease comes a price, but there are alternatives.
Why businesses use the IRS mileage rate for reimbursements
The business mileage rate issued each year by the IRS has become the standard rate for many companies that reimburse employees for business travel. What was originally designed to allow taxpayers to deduct business mileage has now become the expected method of calculating employee reimbursements for business travel.
For many organizations, accurate mileage reimbursement is not a priority. Finding the easiest solution is. And that’s how a business mileage deduction rate became the standard mileage reimbursement for employees. But that ease carries a high price because that tax deduction tool is based on national averages, not individual travel expenses.
What is the current IRS business mileage rate?
For 2020, the published IRS mileage rate is $.575/mile. That means the standard mileage reimbursement for employees across the U.S. will also be $.575/mile. If that’s your organization, let me ask you two questions:
- What employee expenses does your mileage reimbursement cover?
- How many of your employees actually incur costs equivalent to their reimbursement?
If you cannot answer these questions, you may have a serious problem. How do you know you aren’t overpaying? The problem is, you’re paying a rate that’s not transparent or quantifiable when used as a reimbursement.
What does the IRS rate mileage reimbursement actually pay for?
A mileage reimbursement rate has to cover a wide range of vehicle expenses: gas, oil, tires, maintenance, insurance, depreciation, taxes, registration, and license fees. All these expenses can vary from driver to driver.
Consequently, the idea of a “standard” rate works only in theory, not in reality. The fact is, there’s no such thing as a “standard” employee when it comes to reimbursement for business travel. If you have employees in four different states, these employees are going to pay different amounts to own and operate their personal vehicles:
- Different gas prices
- Different insurance costs
- Different taxes and registration fees
- Different depreciation amounts
- Different maintenance costs
How can paying each employee the same rate cover a variety of costs? Employees reimbursed at $.575/mile will receive $1.00 for every 1.74 miles they travel. That’s not a bad business. When a driver reports 2,000 business miles per month, that’s $1,150 in monthly reimbursement. In many cases reimbursing a driver over $1,000/month will allow them to afford almost any vehicle they want.
What is the reimbursement actually paying for, then?
Driving productively vs. driving for dollars
Paying a cents-per-mile reimbursement, while simple and easy, always carries the risk of overpaying employees – especially at the federal mileage rate of 57.5 cents per mile. Here are two reasons why:
The more mileage employees report, they more money they earn.
A generous cents-per-mile rate like the government rate incentivizes unproductive, unnecessary driving. Even worse, if employees self-report mileage, then they have an incentive to exaggerate their mileage.
Fixed vehicle costs (e.g. insurance, depreciation, etc.) do not significantly increase with increased mileage.
The more you drive, the less it costs to operate your vehicle per mile. Drivers receive a steadily increasing benefit per mile from a mileage reimbursement the more they drive. This is because the cents-per-mile rate doesn’t decrease as their costs-per-mile decrease. The further they move beyond the average mileage for a U.S. driver, the more that $.575/mile rate overpays them.
If your organization is overpaying with the IRS mileage rate, then it’s affecting your bottom line. If you have a lot of mobile employees, then that could be a significant amount of overpayment.
Rate standardization is a problem for cents-per-mile reimbursements
The government mileage rate is not the only way to reimburse your employees. But most organizations don’t want to leave the paradigm of a standardized, cents-per-mile reimbursement.
When an organization sees the costs exceeding what is identified as a “manageable” expense, the typical response/reaction is to:
- Find a mileage log that will help calculate mileage
- Find a mileage log that will make employees more accountable for business travel.
- Reduce the mileage rate.
- Re-establish the commuter rules (i.e. clarifying what counts as business travel).
All of these reactionary steps are efforts to offset the increased costs of business travel. The first two can be particularly helpful in decreasing unproductive driving. But none of these reactions get to the root of the problem.
The root of the problem is the standardized rate. Not many organizations ever question the idea of paying a standard mileage reimbursement for all employees. But given the variations in mileage amounts and the costs of driving (per mile), it makes sense to create variations in the reimbursement rate itself.
When your organization reimburses the IRS mileage rate all you are doing is reimbursing the maximum amount for all employees to drive their vehicle under a type of IRS-accountable plan (i.e. a non-taxable reimbursement plan). It’s not fair; it’s just equal. And expensive.
Alternatives to the IRS business mileage reimbursement rate
There are better alternatives to the IRS mileage rate (or any other standardized rate). The most accurate approach is to separate fixed costs (insurance, depreciation, etc.) from variable costs (gas, tires, etc.) and reimburse each separately. This is called fixed and variable rate reimbursement (FAVR), and it has become the gold standard of auto reimbursement.
To learn more about how you can save money with this alternative, contact mBurse today.