Everything You Need to
Know about Car Allowances

Your definitive guide to developing
an effective car allowance policy in 2021.


To begin this guide we ask five questions about car allowances. You may not know the answers unless you are well read on company car allowances or follow our blog.

That's okay. As you read this guide keep the quiz questions in mind because the answers are interwoven throughout.

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How much do you know about car allowances?

Does your organization employ anyone who travels for work using a personal vehicle? We call them mobile employees. Mobile employees make sales calls, manage accounts, provide training, attend conferences—and more.

These employees should be compensated for the business use of their personal vehicle. Most employers use a set monthly car allowance, a cents-per-mile reimbursement, or some variation on these standard approaches.

If your organization pays a cents-per-mile reimbursement or is considering switching to one, check out our definitive guide:
Everything You Need to Know about Mileage Reimbursements.

If your organization provides a car allowance, and your priority is to find the optimal rate for your employees, then click the box below to start the process.

How much is a fair vehicle reimbursement

Otherwise, read on to discover everything employers and managers need to know about car allowances in 2021.

If your organization pays any form of an employee car allowance, management needs to answer these questions:
  • How did you calculate your employee car allowance amount?
  • How long has it been since you reviewed your car allowance amount?
  • Does the car allowance cover the expenses of every employee?
  • Is the car allowance taxable?
  • If so, are you properly withholding taxes?

While these questions have answers, many organizations opt to keep things simple and go with “whatever works.”

It’s easy to just stick with the same car allowance year after year. Why spend time researching, computing, and re-evaluating your policy when the one you’ve got is simple, understandable, and easy to administer?

But the situation is more complicated. In fact, your car allowance may be costing the company in a variety of ways that are easy to overlook.

This guide will help you pinpoint the strengths and weaknesses of different vehicle compensation policies, including your own. A finely-tuned policy can accomplish a range of company goals:

Money in hand

Save time and money.


Support mobile employees equitably.


Serve as a powerful tool to attract and retain talent.


Protect the company from mobile employee risks.

Chapter 1 - What does a car allowance cover?


What does a car allowance cover?

For a lot of businesses, the burning question is

How much car allowance should I pay?

But before you try to calculate a fair car allowance amount, you have to know what expenses your employee car allowance Must cover.

Fuel is the obvious one, but there are others as well. For the average driver fuel only constitutes 17% of the costs of vehicle operation. Several states (California, Illinois, Massachusetts, Rhode Island, North Dakota, and South Dakota to name a few) have laws governing the reimbursement of mobile employees for work-related expenses. California’s law is the most explicit, so we’ll use it as our guide.

CA Labor Code Section 2802(a) states that:

“An employer shall indemnify his or her employee for all necessary expenditures or losses incurred by the employee in direct consequence of the discharge of his or her duties, or of his or her obedience to the directions of the employer, even though unlawful, unless the employee, at the time of obeying the directions, believed them to be unlawful.”

Furthermore, Section 2802(c) defines “necessary expenditures or losses” to include “all reasonable costs."

CA Labor code CTA

What counts as a reasonable cost?

First, the operational costs. Adding business use to a personal vehicle means both increased fuel consumption and increased wear and tear, with more frequent changes of oil, tires, brake pads, etc.

Second, the ownership costs. If the job requires a vehicle, the employer should reimburse property taxes, registration, depreciation, and car insurance. On average around 60% of the costs of vehicle ownership go to insurance and depreciation.

Suddenly now, the car allowance must cover quite a few expenses:

Fuel, oil, tires, taxes, registration, insurance, depreciation… It adds up, doesn’t it?

Complicating the matter, not all employees experience the same costs. Auto insurance premiums are higher in Michigan than in Oklahoma. Gas prices are higher in California than in South Carolina. Some employees travel 1,000 miles every month while others travel 2,000 miles.

To calculate an appropriate car allowance amount, you need more specific data on geographic variations in driving costs. Learn more by reading Four Steps to a Reasonable 2021 Car Allowance.

At this point you may be wondering if your organization’s current allowance amount should be re-calculated. First, you need to know whether your car allowance is taxable and whether your company is complying with IRS guidelines.



Is my car allowance taxable?

Because tax withholding significantly reduces an employee’s take-home pay, you need to take taxation into consideration when Calculating a fair car allowance. Let’s look at the most common ways to offset employee business expenses and their tax implications.
  • Standard car allowance

    A fixed monthly car allowance is considered compensation, and therefore taxable income at both federal and state levels. Both employee and employer must also pay FICA/Medicare taxes on the allowance. A typical car allowance may be reduced by 30–40% after all these taxes. Consequently, the employer must ensure that the post-tax amount can cover an employee’s vehicle expenses, not the pre-tax amount. Before 2018, employees could write off business mileage to offset these taxes, but the recent tax reform has eliminated that deduction until 2026.

  • Car allowance with mileage substantiation

    A company can avoid taxation by tracking the business mileage of its employees. Every month, each employee’s mileage is multiplied by the IRS mileage rate ($0.56/mile for 2021). The employee then receives the lesser of the car allowance amount and the mileage rate multiplied by the mileage. In the past, excess mileage could be deducted from next year’s income taxes, but that too has changed with the recent tax reform.

  • Car allowance plus fuel card or fuel reimbursement

    In addition to a fixed allowance, the company can supply a credit card used only to purchase gas or reimburses receipts for gas expenditures. Not only is the car allowance a taxable benefit, but so is any portion of the fuel expenditure that cannot be demonstrated as business use. The company must charge back the employee for any personal gas use to avoid taxation.

  • Mileage reimbursement

    Instead of paying a fixed monthly amount, a company can multiply the employee’s monthly reported mileage by a specific cents-per-mile rate and pay the resulting amount as a reimbursement. As long as this business mileage rate does not exceed the IRS standard business mileage rate, the reimbursement remains non-taxable.

  • Car allowance with mileage reimbursement

    In this case the company pays a fixed monthly amount plus a mileage reimbursement. The monthly car allowance is taxable but not the mileage reimbursement, as long as the mileage rate does not exceed the IRS rate.

  • Fixed and variable rate car allowance (FAVR)

    This non-taxable approach combines a fix monthly allowance with a variable mileage rate. FAVR was designed as a corporate tax tool to reimburse employees both tax free and more accurately than a standard car allowance or mileage rate. Unlike other approaches, a fixed and variable rate car allowance achieves precision by using expense data for each employee’s garage zip code to set the fixed allowance and the variable rate.



Chapter 3 - Is-car-allowance-best-fit


Is a car allowance the best fit?

The two most popular business vehicle policies – the standard car allowance and mileage reimbursement at the IRS rate – both come with two advantages: simple to understand, easy to administer.

But as you examine each more closely, you find that simplicity and ease come at a cost.

As the mobile workforce has grown, vehicle reimbursement models that worked in the past have become less of a “fit” for many organizations. Originally, car allowances served as a catch-all to cover car expenses and a way to increase compensation without actually negotiating the salary. When fewer jobs involved travel using a personal vehicle, this system worked fine.

But with cars increasingly becoming a de facto "office," the standard car allowance has not kept up with expense needs. Under-reimbursement has become a problem, intensified by the elimination of the tax deduction for business mileage. A fixed car allowance cannot precisely offset each employee’s expenses, and after taxes, many business drivers get shortchanged.

The solution isn’t as simple as increasing every employee’s monthly car allowance.

That approach could get prohibitively expensive, and an increase might not even be necessary for a low-mileage driver operating in an inexpensive part of the country.

Switching to the IRS business rate can also create challenges. Mileage reimbursement introduces problems with cost control – employees now can drive more to earn more. At 56 cents per mile (for 2021), the IRS rate gets expensive fast.

Both a standard car allowance and a mileage rate share one fundamental problem: applying an equal amount or rate to widely unequal expense needs. 


A company with a variety of employees driving for work cannot address that variety using a standard rate or amount. Disparities will emerge due to varying territory sizes and costs:


Adding variations to these common policy types, such as fuel reimbursement or mileage substantiation, sometimes can help, but they often create new problems. It’s crucial to understand the exact limitations inherent to each policy type before deciding the policy type and amount that would best fit your company and its employees. In the next section, we’ll dig deeper into flaws inherent to car allowances.

3 steps

Chapter 4 -hurdles-image-problems-car-allowances


Problems with standard car allowances

A standard car allowance has three drawbacks that a company must face.
  • Tax Waste

    Given a $500 monthly allowance, how much actually goes to pay vehicle expenses? Less than you’d think. An employee in the 24% tax bracket will take home only $341.75 after subtracting both income taxes and FICA/Medicare. That amount will decrease further if the car is garaged in a state that levies an income tax. On top of this, the company pays $38.25 for FICA/Medicare on that $500.

    Inside the tax waste 

    Given the vehicle expenses an allowance should cover – gas, maintenance, depreciation, insurance, etc. – will that $341.75 truly suffice? Because the IRS considers a car allowance a taxable benefit and not an expense reimbursement, employees are left playing catch up with their income.

    FAVR Calculator

  • Variations in expenses

    A single employee’s expenses can vary month-to-month. Two different employees in the same company can have widely different expenses. Gas prices rise and fall, territory sizes differ, and geographically-sensitive expenses can vary widely.

    Compare the average fuel and insurance costs between three different states:

Car Insurance CostGas Prices

Paying everyone the same amount can create fairness problems, shortchange some employees, and lead to undesirable employee behavior, such as curtailing business trips to save money.

  • Lack of precision

    The 2018 mBurse Auto Allowance Survey revealed that only a quarter of companies calculated their car allowance using vehicle expense data. And 73% had gone ten years or more since last updating the allowance amount. Not surprisingly, in our 2019 survey, 62% reported complaints from employees about the car allowance. How can anyone expect their allowance to meet all employees’ needs when the amount has no basis in data and goes unreviewed for years?

Lack of precision can cause problems

mBurse 2019 Car Allowance Survey

Our 2019 Car Allowance Survey

How to boost car allowance take-home amounts

Let’s be clear about one approach that’s off the table: “Just write it off on next year’s taxes.”

Until 2026 at the earliest, employees cannot deduct unreimbursed business expenses. Previously, employees could track business mileage and deduct the equivalent of the IRS mileage rate, offsetting tax withholding and recouping any gaps between their allowance and their expenses.

But the Tax Cut and Jobs Act removed that deduction for tax years 2018-2025. In our 2019 survey, 61% of employees reported income loss due to the tax reform.

Here are better steps to address car allowance problems that leave employees shortchanged:

reimbursement table

As you can see, taking any step to address the shortcomings of car allowances will cost time or money or both. Most solutions require adding a mileage log as well. But to do nothing will cost far more in the long run – a point we’ll return to later.

mBurse 2020 car allowance checklist

Car Allowance Best Practices

Simply switching to a mileage reimbursement like the IRS mileage rate cannot solve the problems of expense variations and lack of precision and adds a new challenge: cost control. (See Why the IRS Mileage Rate Is Terrible for Business.)

Only a fixed and variable rate car allowance can eliminate tax waste while solving these problems. We’ll explain this, and how a FAVR program is more cost-effective. But first, let’s look at how your car allowance policy impacts every aspect of the company.

Chapter 5


How your car allowance affects every aspect of the company

Getting the vehicle policy right or wrong can impact numerous parts of an organization.

We’ve already covered tax waste and inequitable compensation of employees due to expense variations. But there’s also a domino effect that touches other aspects of an organization:

Risk management

If you fail to sufficiently reimburse all employees, you open the door to labor code lawsuits and to employees taking risky measures to cut costs. For example, an employee might reduce insurance coverage. If that employee causes a car accident while working, your company’s insurance may be forced to close the gap between the employee’s insurance and the costs of the accident.

mBurse_Mobile Employees and Risk_eBook

Is your company exposed?

Employee productivity

Under-reimbursed employees may also recoup lost income by reducing the amount of driving they do. Reduced travel can mean fewer face-to-face meetings with clients and potential clients. Over time, less driving may compromise sales productivity and client relations.

Attraction and retention of employees

Some employees will simply leave the company if they cannot obtain equitable reimbursement. Check your attrition rates. If it has been years since you’ve adjusted the allowance or reimbursement, don’t be surprised if attrition has increased. Similarly, if prospective employees project insufficient reimbursement, they may not seek or accept a job at your company.

Chapter 5 man-checking-watch-is-car-allowance-legally-compliant


How to keep car allowances IRS and labor code compliant

The strict labor laws of California, Massachusetts, and now Illinois could spread to other states.

The tax reform has made paying a fair car allowance in 2021 a necessity. The changes in tax deduction rules place pressure on states to tighten vehicle reimbursement rules, and company car allowances face higher levels of scrutiny.

As we've already established, under the Tax Cut and Jobs Act (TCJA), employees cannot write off unreimbursed business expenses during the 2018-2025 tax years.

This change poses a problem for companies with employees in employee-friendly states like California and Massachusetts that have reimbursement indemnification labor codes. These laws prohibit companies from passing business expenses to employees. Illinois just passed a similar law effective January 2019, and other states may follow suit in the wake of the tax reform.

Employees in these states are now more likely to use labor laws to force companies to cover their loss of income due to the tax reform (Our 2019 Survey found that 61% experienced such a loss of income.)

Moderate-to-high-mileage drivers who receive a standard car allowance have been particularly impacted. A comparison of 2018 and 2019 tax deductions shows why:

Two examples of drivers in 2019:

2019 popular tax deduction is gone

Driver 1 received an enormous benefit under the old tax code. That $21,800 deduction equated to more than a $5,000 decrease in taxes at the 25% tax bracket. But the 2018 tax bracket reduction to 24% covered only a fraction of the loss of that gigantic business expense deduction.

Driver 2 received a lesser benefit under the old tax code with fewer miles driven and an allowance that came closer to actual expenses. But it was a significant benefit nonetheless that will not exist until at least 2026.

TCJA 2019 eBook

Tax Reform eBook

Tax reform impact 1: Employees seek recourse 

In the wake of the lost tax deduction, mobile employees are seeking recourse. While some may drive less or look for new employment, others may take legal action under state labor laws. Class action lawsuits in employee-friendly states are now more likely.

Tax reform impact 2: States amend labor codes

Increased numbers of employees seeking full reimbursement from their employers may increase the number of states that indemnify employees from company expenses. Illinois is just the beginning. Taking a company to court over insufficient reimbursement could get easier in other states.



How to calculate the right car allowance for 2021

The new tax landscape has raised the stakes for companies across America. This adds urgency to the quest for a fair 2021 vehicle reimbursement policy.

In 2019, millions of mobile employees filed their taxes and realized for the first time that they could no longer deduct business vehicle expenses. If their employers failed in 2020 to adjust in response, these employees may have taken steps to obtain recourse.

Companies that have adjusted now have a competitive advantage over those that didn't.

Now is the time to take concrete steps to investigate and adjust your policy. At the very least, you need to do the following:
  • Estimate actual employee vehicle expenses and compare these with your current allowance amount. Then calculate the car allowance amount needed to close any gaps.

  • If you’re paying a taxable car allowance, calculate how much your organization could save by switching to an accountable (non-taxable) plan. The elimination of tax waste could be all you need to fully offset employee expenses.

  • If you’re using a fuel card or fuel reimbursement, calculate whether fuel consumption matches business productivity and find out whether your organization is properly limiting personal use.

  • Learn more about the fixed and variable rate car allowance. FAVR is the most accurate and legally defensible policy type, and it’s completely unaffected by the elimination of the tax deduction because it ensures accurate reimbursement.

Fair car allowance amount

The question remains: How much car allowance should you pay in 2021?

Hopefully, you’ve figured out the answer: It’s complicated!

Because mobile employees within the same organization often experience widely different costs, there’s no quick and easy way to determine the right amount. Without knowing an employee’s mileage and zip code and the size of vehicle required to carry out the job, it’s impossible for someone to tell you the right amount.

But there are some clear-cut principles that you can follow:

  • t-shirt-icon-for-one-size-fits-all One-size-fits-all CANNOT be your solution.

    Because expenses among employees will vary, the car allowance amount should vary. It’s possible that a small company with a narrow range of employee expenses can get away with a standard allowance amount, but even then there will be disparities between expenses and reimbursement for some employees – and tax waste will still be a problem. The limitations on vehicle travel due to Covid-19 also can affect employees to different degrees depending on where they live.

  • Texas-map-icon-for-employee-territory-size Territory size MUST factor into the amount the employee receives.

    The number of miles driven affects everything from fuel consumption and tire wear to maintenance and depreciation. Employees with larger territories will drive more, and you have to take this into account. Failing to incorporate mileage into the amount will result in low productivity from shortchanged employees.

  • gas-dispenser-icon-for-fuel-factor-in-car-allowance Geographically-based costs MUST affect the amount the employee receives.

    Gas prices, insurance premiums, taxes, registration/license fees, and maintenance costs are regionally-sensitive. And some will be higher than you expect. It’s vital to calculate, given a reasonably-sized vehicle garaged in a particular zip code, what each employee’s expenses will be and to incorporate that data into the amount the employee receives.

Data needed to calculate a car allowance

Different employees should receive different amounts and those amounts should be based on actual data. This is the only way to ensure equitable reimbursement and to prevent the costly consequences of over-reimbursing and under-reimbursing.

To get started, use the graphic below to discover the average costs of owning and operating a vehicle by expense category. You might be surprised at what you find.

Car graphic

These average annual costs amount to a monthly expense of $615.50. And that’s average. Will a $600/month taxable car allowance cover the costs of the average American driver? No way! After taxes, that $600 might be as little as $400.

What about a driver in California, where gas and maintenance prices are through the roof? Or in Michigan, where insurance rates are the highest in the country? Those drivers' monthly vehicle expenses could easily reach $1,000.

Would a mileage reimbursement work better? Not necessarily. Depreciation and insurance together make up 60% of vehicle costs. That poses problems for low-mileage drivers since fixed costs are only marginally affected by miles driven.

What's your optimal car allowance for 2021?

At this point, you could use these average costs to estimate the needs of individual employees based on whether they face below average or above average costs as determined by geographic location, territory size, and vehicle type. But you could also use tools that will give you more specific data.

To give you data specific to select vehicle types and a selection of geographic locations, we have created an additional guide to the process of pinpointing that optimal allowance or reimbursement rate: Four Steps to a Reasonable 2021 Car Allowance.

Or, you can complete our three-step process below – audit your current car allowance, complete a competitive benchmarking analysis, and then receive a free, optimized rate.



Conclusion: Fix your car allowance now

You have a responsibility to protect each employee’s income from the costs of using a personal vehicle for work.

There are IRS-accountable plans designed specifically to help businesses address the variety of vehicle expenses their employees experience. Why waste money on taxes when you could both save money and boost your employees' take-home pay? The time is now – review the recommendations throughout this guide, and commit to improving your car allowance policy today.

It is now 2021. Employees know that they cannot deduct business mileage anymore. They face even more economic uncertainty due to a pandemic. If you wait any longer to improve your policy, what will the consequences be?

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Car Allowance & Reimbursement Best Practices Checklist

The Definitive Guide to Car Allowances
2020 car allowance guide
Read the PDF version
2020 car allowance guide

The Definitive Guide to Car Allowances