Everything You Need to Know about Mileage Reimbursements

A lot of businesses just want to answer a single question:

What’s a reasonable mileage reimbursement in 2024?

Many will say the IRS standard business rate, or federal mileage rate – 67 cents per mile. But that response misunderstands employee vehicle reimbursement. To determine an appropriate reimbursement rate, you need to know what expenses a mileage reimbursement actually covers.

The most obvious expense is gas, but on average, gas only constitutes 17% of a driver’s vehicle expenses. Reimbursable expenses covers a wide range. By requiring an employee to use a personal vehicle for work, a company assumes an obligation to defray the full array of vehicle ownership costs. The employee is hazarding an expensive piece of personal property, and that employee should expect a comprehensive reimbursement for vehicle expenses.

A number of employee-friendly states (e.g. California, Illinois, Massachusetts, Rhode Island, North Dakota, and South Dakota) have labor laws protecting the use of a personal vehicle for work.

If your organization already pays a mileage rate, it may be because management was trying to avoid a taxable reimbursement plan.

As you consider changes to your mileage rate or switching to another reimbursement model, it’s important to know what IRS guidelines consider taxable (a.k.a. non-accountable) vs. non-taxable (a.k.a. accountable).

The primary distinction lies between reimbursement and compensation. If the employer can demonstrate that all payments distributed to offset vehicle expenses were matched to business use of the vehicle, then those payments are considered reimbursements. If the employer cannot demonstrate business use, the payments are considered compensation and therefore taxable.

Generally speaking, any mileage reimbursement up to the IRS business rate is exempt from taxation, whereas a standard monthly car allowance is taxable compensation.

Below is a list of common business vehicle plans and whether they are considered reimbursements (non-taxable) or compensation (taxable).

The two most popular business vehicle policies – the standard car allowance and mileage reimbursement at the IRS, or government, mileage rate – are popular because they are easy to understand and simple to administer.

But simplicity and ease come at a cost.

As the mobile workforce has grown, these “one-size-fits-all” reimbursement models have become less of a “fit” for many organizations. The standard car allowance often fails to keep up with employee expenses because taxes reduce take-home pay and because it does not adjust up for drivers with large and/or expensive territories.

Similarly, the IRS mileage rate, created as an individual tax deduction tool, has become less suitable as the number of mobile employees and total mileage amounts have increased. The government mileage rate, intended only as a measure of average vehicle costs, cannot capture costs with precision. This lack of precision increasingly proves problematic as the number or variety of mobile employees increases within an organization.

Not only do employees drive different amounts, but they also face different geographically-sensitive costs.

Compare the average gas prices and insurance premiums across three different states:

A single mileage rate can work if all employees live in similarly-priced geographic regions and drive similar amounts per month. However, a company that operates in multiple regions will have employees facing very different geographically-sensitive costs, such as fuel and insurance.

A small company whose employees all drive between 1,000 and 1,500 miles per month may find the IRS mileage rate a suitable tool, but a larger company with more high-mileage employees may find the government rate unaffordable. The IRS rate will over-reimburse these high-mileage employees and under-reimburse drivers who cover small territories yet still face high fixed costs (e.g. insurance, depreciation, taxes).

Standardized car allowances and mileage rates share the same problem: equal compensation for unequal expense needs.

A standard rate or amount cannot address the variety of expense needs that arise with employees covering a variety of territory sizes in different parts of the country. Disparities will emerge:

To determine whether a mileage reimbursement is the best plan for your company, you need to fully explore the challenges inherent to paying a standard rate to a variety of mobile employees. The next section will delve further into each of these challenges and the reimbursement best practices needed to solve them.

Mileage reimbursement at a standard rate creates three challenges that you need to solve: expense variations, lack of precision, and cost control.

If you do not have a reimbursement plan that follows best practices to address each of these challenges, the company can experience increased attrition rates, increased chances of labor code violations, and inability to rein in costs. 

1. Expense variations

In theory, a mileage rate should help with expense variations because more driving incurs more costs. In reality, vehicle expenses fall into two categories: fixed and variable.

Fixed costs, such as insurance, taxes, and depreciation, become less costly per mile when spread over a higher number of miles driven.

Variable costs, such as gas, maintenance, and tires, tend to increase with miles driven, though other factors such as gas prices impact these as well.

As a result, a high-mileage driver tends to be over-reimbursed relative to a low-mileage driver. Here’s an illustration using the 2019 IRS rate, which was $0.58/mile that year:

Both employees pay the same amount for their driver’s license, vehicle taxes, and car insurance (for the most part). Employee B will spend more on maintenance and tires and spend a lot more for gas. But Employee B is not going to spend $14,210 more in gas, maintenance, and tires than Employee A. Plus, Employee A’s car depreciation by itself will likely exceed $2,000.

Here is a comparison of the average business costs of a midsize vehicle driven 5,500 vs. 30,000 miles:

Employee A got shortchanged. Employee B made bank. This is a huge inequality, and it happens all the time.

Most mileage rates do not fluctuate with gas prices, adding to the problem. For example, the IRS rate only generally tracks with gas prices but historically has not adjusted with spikes.

2. Lack of precision

The IRS mileage rate was never designed to accurately reflect all motorists’ vehicle costs. Instead, the government rate is derived as an average of all vehicle expenses across the entire United States from the previous year, which works just fine in terms of taxation but less so for companies seeking to accurately reimburse employees.

Different motorists in different parts of the country experience different levels of expense per mile driven. But as far as the IRS is concerned, it all averages out across all tax returns. Some taxpayers end up deducting more than their actual costs, while others less than their actual costs – but it all evens out for Uncle Sam.

If mobile employees are being shortchanged by the IRS rate, they may drive unnecessary miles to increase their reimbursement. If they are being over-reimbursed, however, that becomes an expense problem for the company.

3. Cost control

Most companies rely entirely on the employee to record business mileage. This creates a cost control problem.

Because neither the IRS mileage rate nor most company-derived mileage rates adjust automatically with gas prices, there are times when a sudden increase in gas prices brings a sudden decrease in cash flow for the employee. The same thing happens if their insurance or personal property tax rates increase.

Getting your vehicle reimbursement policy wrong can impact nearly every aspect of your organization.

We’ve already covered problems with cost control and inequitable compensation due to expense variations. But weaknesses in a reimbursement plan can impact other aspects of an organization:

Vehicle reimbursements have assumed even greater importance under the current tax code.

Under the Tax Cuts and Jobs Act (TCJA), enacted December 21, 2017, employees cannot write off unreimbursed business expenses during the 2018-2025 tax years.

In the past, an employee receiving a mileage rate less than the IRS business rate could deduct the difference between their company’s mileage rate and the IRS rate. An employee receiving the IRS rate could deduct the difference between actual expenses and the total mileage reimbursement benefit.

Either way, the employee had recourse to offset an insufficient car reimbursement plan. Now, drivers may seek other recourse, such as lawsuits for labor code violations.

The elimination of this popular deduction puts pressure on companies operating in employee-friendly states like California and Massachusetts with labor codes that indemnify employees from business expenses. These labor laws strictly prohibit companies from passing on business expenses to employees.

In January 2019, Illinois enacted the same kind of law. Other states may also begin dictating full reimbursement in the wake of tax reform. There’s already a group of states with labor code protections that favor employees when it comes to business expenses (CT, RI, MI, ND, and SD).

Employees will increasingly pursue full reimbursement from their employers. State legislatures will increasingly face pressure to pass new labor laws protecting employees.

The current tax landscape combined with rampant inflation necessitates getting your car reimbursement policy right.

For four years now millions of mobile employees have filed tax returns without being able to write off vehicle expenses using Form 2106. Employers that have not increased their vehicle reimbursements commensurably are facing renewed pressures.

From 2021 through 2023, inflation hit vehicle costs hard. Workers are feeling whiplash and financial uncertainty. They need to know that their employer will responsively make adjustments to protect their income.

Unless you’re already properly reimbursing your employees, sticking with the status quo will hurt your company and your employees.