Without even knowing it, your company’s car allowance or mileage reimbursement may be violating state labor codes. It’s important to take the time to educate yourself and avoid costly fines or lawsuits.
Most organizations with employees that drive as part of their job offset travel expenses through either a car allowance or mileage reimbursement. But not everyone realizes there are labor codes that dictate how allowances and reimbursements should be paid. Many of these labor laws indemnify employees from any expenses incurred using their personal vehicles for business.
Examples of expense-related labor codes
Employee-friendly states like California, Illinois, Rhode Island, Massachusetts, North Dakota, and South Dakota have laws mandating the proper reimbursement of business expenses like cell phones and personal vehicles. There have been many landmark cases against major corporations (examples: Starbucks, Sysco Foods, Radio Shack) that have resulted in multi-million-dollar fines, and settlements.
The most comprehensive employee indemnification law is California Labor Code 2802(a). When it comes to vehicle reimbursements, this law requires that the reimbursement rate or allowance amount be quantifiable and accurate. However, very few companies actually devote the time and resources necessary to quantify employee vehicle expenses and match their reimbursement or allowance to these expenses. This leaves many companies vulnerable to costly consequences if they are sued for a labor code violation.
Consider your own organization:
- What is your car allowance amount or mileage rate based on?
- When was the last time your company reviewed this amount?
- Can you say with confidence that all employee vehicle expenses—including fuel, insurance, depreciation, maintenance, tires, and taxes—are fully being offset?
The answers to these questions could indicate your risk of a labor code violation.
Tax reform: a complicating factor
If you cannot confidently state that your organization disburses a quantifiable and accurate vehicle reimbursement or allowance, then you need to review your policy ASAP. Why? Tax reform.
Under the new tax code, individuals cannot write off unreimbursed business expenses for the tax years 2018 – 2025. This means that employees who utilized this tax provision in the past to make their reimbursement whole will be looking for recourse to replace this loss of income.
State labor laws are designed to offer exactly this kind of recourse. You can bet that reports of violations and class action lawsuits will increase as employees discover that they can no longer rely on the tax deduction to protect their take-home pay. This is why it’s crucial for your organization to review its policies now and make adjustments that indemnify employees from vehicle expenses. (For more insight, read “Surviving the Tax Code-Labor Code Tug of War”).
How to review your car allowance or mileage reimbursement
Historically, car allowances and mileage reimbursements were handled in the simplest ways possible. However, this simplicity is exactly what will expose businesses to labor code violations in this tax reform era.
Let’s look at the two most common approaches and how to review them for weaknesses.
- Flat, taxable car allowance
Many organizations opt to provide a consistent monthly amount to all employees, regardless of territory costs or territory size. This approach involves two particular problems. First, because employees experience widely varying expenses, there will unquestionably be employees who find their expenses exceed their allowance. Second, taxes eat into everyone’s take-home pay, often by as much as 30%, increasing the likelihood that a significant number of employees will be shortchanged.
Under the old tax code, employees just deducted their business mileage to make up for an insufficient allowance. But that will change as they file their 2018 taxes in just a few months.
2. Mileage reimbursement rate
In theory, paying a reimbursement based on mileage should result in a closer relationship between expenses and reimbursement. In reality, employees experience significant differences in territory costs and sizes, raising the question of whether a standardized rate can truly meet everyone’s needs.
One problem with paying a mileage rate is the relative percentage of fixed expenses (depreciation, insurance, taxes) compared with variable expenses (fuel, maintenance). Two employees working in the same part of the country will experience similar fixed expenses, but if one has a much larger territory, that employee will get a much higher reimbursement by virtue of reporting more mileage. The low-mileage employee may experience a significant shortfall because his or her reimbursement is not enough to cover the fixed expenses.
Remember, if you cannot prove that your mileage rate fully reimburses all employees, then you are at risk of violating labor laws in employee-friendly states.
But what about the IRS mileage rate? This rate has typically been viewed as the standard for sufficient reimbursement; however, the argument is increasingly being made that the IRS rate does not truly meet the CA Labor Code 2802(a) standards of “accurate and quantifiable.” Consequently, we expect to see the IRS mileage rate challenged under California’s labor code. Don’t assume that, because you are paying the IRS mileage rate, you don’t need to make adjustments to your vehicle reimbursement policy.
What not to do in when reviewing your policy
Discovering that your organization is at risk for labor code violations could lead to quick changes that ultimately prove riskier than the current situation. For example, you might decide to boost your car allowance for all employees. It’s an expense you can budget for, and it’s better than paying hefty fines or dealing with a disastrous lawsuit. However, this approach could mean overpaying some employees in order to address employees who are currently underpaid. Plus, this will only increase the chunk of change that goes to taxes—an inefficient way of solving the problem.
Alternately, you might decide to add or switch to a mileage reimbursement, or increase your mileage rate if you already use one. But mileage reimbursements already carry with them the difficulty of controlling costs due to employee-reported mileage. And, as demonstrated above, an inequitable situation exists between high-mileage and low-mileage employees, which will only be worsened.
With all of these approaches, the standards of “accurate and quantifiable” remain unaddressed, leaving you exposed even as you pay more. To properly protect your organization from labor code violations, you will need to take a more complex approach that starts with getting data on actual employee expenses.
After reviewing the policy, then what?
In part 2 of this blog, we will discuss how to make policy changes that will cost-effectively reduce your risk of a violation. In the meantime, you should begin reviewing your current policy as soon as possible. As a result of the tax reform current indemnification labor codes will get more visibility and more states will adopt similar labor codes. In the interim many employees will either complain or leave the company because their expenses are not being covered. Don’t wait until 2019 to address this looming problem.