Why Is It Important to Review Your Car Allowance Policy?
Since the Tax Cut and Jobs Act, deducting business mileage on the tax return has been eliminated for the tax period 2015-2018. This means that your employees can no longer use their previous year's business mileage to reduce their taxable income.
The tax reform has caused loss of income to many employees. Previously they could keep track of their business mileage and deduct the equivalent of the IRS mileage rate on the tax return.
Financial uncertainty caused by the pandemics and increasing inflation has only complicated matters further, leaving employees worried about their finances and their future.
The odds are high that unsatisfied employees, such as the ones whose car allowances do not meet their expenses, will leave for companies that will fully reimburse them.
In some states, such as California or Illinois, labor laws protect employees' rights and require full business expenses reimbursement, so companies can even face lawsuits and labor code complaints.
To avoid such adverse outcomes, make it your goal to review your car allowance policy. By reimbursing your employees fairly, you provide certainty both to your valuable employees and your company.
How Does Car Allowance Work?
Car allowance reimburses employees’ costs for the use of their personal vehicle for work-related purposes. These expenses include fuel, maintenance, and other costs of operating a vehicle.
The payment will differ depending on your business - what kind of travel your business requires and how the refund is set up. Some companies offer cents-per-mile mileage reimbursement systems, while others use flat monthly allowances.
Business owners are sometimes tempted to economize by providing their employees only a small monthly amount as a car allowance or offering no car allowance at all. Even though it may seem like they are saving a bit of money, they work against their reputation and ability to attract and retain top talent. In addition, they can harm the company in terms of productivity and business efficiency.
If their car allowance doesn't meet their actual costs, employees may be tempted to make risky decisions. For example, they may choose to have state minimum insurance coverage. If they cause an accident while traveling for business purposes, the company may be held accountable and pay for the expenses the insurance doesn't cover. Employees that are not fully compensated for their costs may also choose to travel less, consequently hurting the efficiency.
However, before setting up your car allowance policy, or reviewing the existing one, check the laws in your area. Some states have regulations requiring you to reimburse workers for using their cars for work. As we've mentioned before, California demands reimbursement of all reasonable costs, such as ownership and operational expenses, insurance, etc.
Even though many states do not have these regulations, car allowance is a common practice. It is considered fair to refund employees for their expenses for operating a vehicle for business purposes. Whether you offer mileage reimbursement or a flat monthly amount, car allowance is an essential benefit.
However, when reviewing your existing or setting up your car allowance policy, it's essential to remember that income taxes also apply to car allowances. One of the crucial steps is to consider how taxes are related to the car allowance method you choose and how they can impact the amount your employees take home.
Is Car Allowance Taxable in the US?
In the US, the car allowance tax can significantly reduce the amount your employee gets to cover their vehicle expenses, even by 30-40%.
We've listed the most common tax implications below depending on which car allowance method your company uses.
Fixed car allowance is taxable income at both the state and federal levels. It is a fixed amount paid for employees’ vehicle expenses. However, as both the employer and the worker must pay FICA/Medicare taxes, the amount your employees actually get to keep from their car cash allowance is much lower.
When reviewing a car allowance policy, the employer must confirm that the employee's take-home pay can cover their actual vehicle expenses, not just take into account the pre-tax amount.
However, if you opt to raise your current car allowance, you will increase your costs and the amount of money going to taxes. Without solving the problem of inaccurate business expense reimbursement, you won’t be helping your business become more efficient.
An employer can avoid taxation by sticking to an accountable plan, keeping track of an employee's business mileage, and paying mileage reimbursement or substantiation.
The mobile worker then gets a car allowance in the amount of the mileage multiplied by the millage rate. Such amount is tax-free if it does not exceed the IRS business rate, which is $0.585/mile for 2022. The amount also should not be higher than the actual cost of driving for business purposes.
Instead of increasing the taxable car allowance, some employers choose to add fuel reimbursement or a fuel card. However, this method is also taxable unless the employees log business mileage. In certain situations, companies that opt for such a solution might even need to charge back or tax their employees for any personal use of gas.
As you can see, how much tax you pay on car allowance, largely depends on the method you choose to cover for your employee vehicle use expenses.
Accurate mileage tracking has proved to be crucial for the efficiency of your car allowance policy. The reasons are numerous, and we will just mention a few. First, it grants your employees that they will be reimbursed properly as they will get paid for each mile. Second, if you’re audited, you will need to have a transparent record of the miles as proof of your tax deduction. Third, with timely insight into the mileage, you will be able to control your expenses.
According to different internet sources, the average car allowance for mobile employees for the previous year was $575, the same as the year before. However, there are many reasons why you should definitely consider reviewing it this year. In 2021, there were quite a few trends that affected driving-related expenses.
First of all, fuel prices rocketed, reaching the highest price since 2014 - in October 2021, Americans were paying $1 more for a gallon than in 2020. On the other hand, the expense of insurance continued to increase. At the same time, various disruptions in the supply chain kept depreciation costs at a very low level.
It may happen that even if you use the IRS mileage business rate, the car allowance you pay your mobile workers won’t be enough to reimburse all the vehicle-related expenses.
How Do You Calculate Car Allowance?
To properly calculate the car allowance amount, you need to know what expenses it should cover.
If your company issues vehicles, your employee vehicle allowance will need to reimburse a much narrower set of expenses.
When paying a reimbursement or car allowance to cover the use of a personal vehicle, the following expenses should be factored into your rate:
fixed costs, such as depreciation, insurance, registrations, various fees, and taxes
variable costs such as fuel, oil, tires, and maintenance.
What Is the Best Car Allowance Fit?
Keep in mind that employee’s vehicle-related costs vary from one geographical area to another and that some of the expenses also depend on the type of vehicle. That’s why it’s hard to find a one-size fit all solution.
Let’s take for example the IRS mileage rate. It is based on an annual study of variable and fixed costs of using a car. These costs include insurance, maintenance, depreciation, repairs, gas, tires, and oil.
However, when your employees receive the same mileage rate for two different territory sizes and locations, there might be an inequitable difference in their take-home pay.
If you use the standardized IRS mileage rate, keep in mind that it can lead to excessive driving, as with high-mileage drivers, ﬁxed costs spread out over a larger number of miles.
These drivers can cover their costs more efficiently than those who drive lower miles.
If you have employees across the country, to ensure they are not over or underpaid, you may opt for a "fixed and variable plan," also known as FAVR. Such car allowance can be tailored to fit each employee's actual costs. FAVR consists of:
* periodic fixed payments - insurance, registration fees, depreciation, taxes for the percentage of time the car is used for business and
To determine the car allowance amount accurately, you will need reliable data. If your workers are traveling for business purposes in and from various geographical locations, their costs also need to be treated location-specific.
The Importance of Accurate Mileage Tracking
If your car allowance reimburses your workers using an IRS optimized mileage rate, keeping it does not protect your company from inaccurate mileage tracking and its possible negative outcomes.
The main weak point of mileage reimbursement is self-reported mileage. Still, many organizations rely on manual mileage tracking and use various mileage log templates and spreadsheets to record and calculate employee mileage. However, this method carries many vulnerabilities, the most common being:
* Mileage overestimates. The validity of self-reported driving exposure is highly questionable, which research has also confirmed. Self-reported mileage is often based on guesstimates, resulting in overestimating miles. Also, to compensate for increased costs, some of the employees can inflate their miles on purpose.
* Untimely reporting. Mileage is often calculated and reported weekly, sometimes even just twice a month. But, if your employees do not record mileage right after their trip, they are most likely to forget the exact routes or make calculation mistakes.
* Mixing up personal and business mileage. Your employees may sometimes take detours for personal purposes. Some will leave these miles out of their mileage calculations, but others won’t.
* Logging and keeping reports. The days of paper logs are far behind us. It takes too much time, space, and energy from every single employee who has to deal with the manual mileage logging and their further processing.
With all these vulnerabilities, a GPS-based mileage tracking app such as Timeero is vital to accurately and transparently record trip lengths. Without intruding on your staff’s privacy, you can have real-time insight into your employees' work-related routes, their mileage, and expenses. This way, you will be able to reimburse costs properly.
If your employees are using their private vehicles for business purposes, you want them to be paid fairly for their expenses. You can achieve this by reviewing your car allowance policy.
The first step is simple - you just need to calculate your employees’ actual costs, considering the exact miles and other location-specific expenses.
This way, you will determine whether your car allowance actually covers the costs, or you have a potentially unsatisfied employee getting ready to churn or file a lawsuit.
And if you don’t find this calculation simple, you lack reliable data. GPS mileage tracking solutions, such as Timeero, will never again leave you with doubt on how many miles each one of your employees traveled for business purposes.
Automate mileage tracking and avoid inaccurate reporting
Andjelka is a sociologist turned digital marketer. She specializes in creating content for SaaS and software companies. When she’s not researching the most effective employee management techniques, Andjelka loves cooking, reading, and fighting for human rights.