What Is the Difference Between a Car Allowance and Mileage Reimbursement?
Car allowance and mileage reimbursement are two ways to provide your employees with financial support for using their own vehicles for business purposes.
Car allowance is a fixed amount of money provided to your employees regardless of how much they drive. This payment is usually subject to income tax by the IRS.
Mileage reimbursement is a variable amount of money that compensates your employees a fixed cents-per-mile rate depending on their mileage count. This payment is tax-free if you opt for the IRS business mileage reimbursement rate.
Let’s take a closer look at how car allowance and mileage reimbursement work and compare their advantages and disadvantages.
How Car Allowance and Mileage Reimbursement Work
You pay car allowance to your employees to offset the company use of their personal vehicles. You can pay it weekly, bi-weekly, or monthly as a part of their salary. Unfortunately, this also makes it taxable.
With a car allowance, you cover automobile costs such as:
The key part is that the amount of cash stays the same month by month, no matter how much they actually drove for business purposes.
Example: Emma is a nurse for a home health care agency. She drives her own car to visit patients in-house. Her company gives her a set amount of $700 monthly to cover these business expenses. Every month she gets the same car allowance regardless of how much she drove the car.
On the other hand, mileage reimbursement works just how it sounds — you reimburse your employees a fixed cash rate based on how many miles they drove for company purposes. For this to work, your employees must track how many miles they drove for your business and provide precise mileage logs and cost reports. Using mileage tracker apps can help accurately measure business miles and streamline mileage reimbursement (more on that later).
Remember that the IRS specifies the Standard Mileage Rate for every year. The IRS determines it via the national average of such costs. Lots of companies decide to reimburse their employees at this rate. For 2023, the IRS Standard Mileage rate is 65.5 cents per mile driven for company use.
On the other hand, some businesses reimburse their staff lower or higher than the Standard Mileage Rate, based on whether the expenses are lower or higher in their region.
Example: Martin is a sales rep for a pharmaceutical company. He drives his car to visit new and old clients. Sometimes he goes to the next city; other times, he visits other states. His company pays him 65.5 cents for every mile he drives to see clients.
Now that we understand how car allowance and mileage reimbursement work, let’s explore their pros and cons.
The Pros and Cons of Car Allowance and Mileage Reimbursement
The Tax Cut and Jobs Act (TCJA) removed the popular write-off for taxes on unreimbursed company costs. That’s why accurately reimbursing your employees is more crucial than ever.
So, car allowance or mileage reimbursement, which way to go?
The Pros of Car Allowance vs. Mileage Reimbursement for Employers
A car allowance is a straightforward way to compensate employees for using their personal vehicles for business purposes.
When you opt for a car allowance, you give your employees a flat rate monthly car allowance, regardless of how much they drove for your company.
The method’s main advantage is simplicity, meaning less hassle and confusion. You only have to decide how big the car allowance is and when and how your employees will get paid, and you’re ready to go.
Plus, you’ll spend less time thinking about it. Time management is a key entrepreneurial skill.
The Cons of Car Allowance vs. Mileage Reimbursement for Employers
Tax Waste of a Car Allowance
When it comes to car allowance or mileage reimbursement, only the former is always taxable. In fact, you can lose anywhere from 30% to 40% to taxes on car allowance. For example, if you provide a $500 car allowance, how much does your employee actually get? Probably less than you imagine.
If your worker is in the 24% tax bracket, they will only get around $350 after we subtract FICA/Medicare and income tax. This amount is even smaller if their vehicle is based in states that levy income taxes. Since the car allowance you provide needs to cover maintenance, fuel, depreciation, and insurance, it’s hard to believe that $350 will be enough. Furthermore, since the IRS considers tax allowances as taxable benefits and not cost reimbursements, your employees must keep up with their income.
Moreover, even though you’ll easily report a car allowance to the IRS, you will greatly increase your business’ FICA — Federal Insurance Contributions Act — tax liability. Other methods of reimbursement, including mileage claims, can be free of taxes. On the other hand, a car allowance isn’t based on actual costs. That’s why car allowances are subjected to employee income taxes and FICA taxes for employers.
Fairness, Overpaying, and Underpaying on a Car Allowance
When you compare car allowance and mileage reimbursement, it’s tough to determine a fair amount for the former. How can we actually know how much cash our employees require to operate and own their cars?
It’s very easy to overpay some employees and underpay others. For example, one of your employees drives hundreds of miles daily to visit various clients. At the same time, others may only use their car for commuting. This leads to unfair allowance amounts.
Even worse, you can set up the allowance to be too high. This way, you’ll pay your employees for driving they never did. Some states even consider this an expense fraud. Not to mention that you could be shortchanging other employees. This leads to unwanted worker behavior. For example, they could curtail company trips to save cash. Drive less. Even not driving at all.
The math is simple. Car allowances directly motivate mobile employees to drive less. The less they drive, the more money they keep and the less wear and tear on their vehicles. Ultimately, you pay more for car allowances.
If your company has high-mileage employees, a car allowance introduces possible class-action lawsuits. This is because employees can claim they were underpaid.
Car expenses will vary greatly when your team is based in various regions. This leads to more systemic imbalances. Furthermore, their vehicle expenses can differ from month to month. Fuel prices follow the market. Sometimes they go up; other times, they fall.
And these are just the variations in gas. Add to that the differences in insurance and maintenance, and you’ll easily see why it’s hard to determine the right car allowance accurately.
Not to mention that some states have labor codes that determine the timing and amount of a car allowance, so if you aren’t careful, you can even violate the law. Obviously, this leads to further costs.
When choosing between a car allowance program or mileage reimbursement, the math on the latter is also simple. You won’t have trouble calculating and using mileage rates.
If your employees efficiently track their mileage and the rate you use for reimbursement doesn’t exceed the standard rate, your mileage reimbursement isn’t considered an income. This way, you can deduct this compensation from your taxes.
Moreover, mileage reimbursements are way more accurate. This means they’re fairer to all employees than giving everyone a fixed amount for their car. There isn’t any underpaying or overpaying for employees who use their cars less or more than others in your company.
Disadvantages of Mileage Reimbursement
Yes, it’s easy to go with the former when it comes to mileage reimbursement or car allowance.
But at the same time, you have to take extra care. If your employees miscalculate their mileage, you could end up paying them more. This obviously impacts your bottom line.
Fortunately, if you implement a mileage tracker app, you will dodge such issues as you can entirely automate the process.
Other disadvantages of mileage reimbursement include:
Risks of labor code violations when the company can’t substantiate the rate.
Less accuracy when you compare high-mileage and low-mileage employees.
You will need some time to determine the right cents-per-mile rate.
Before calculating your car allowance or mileage reimbursement, you must know what expenses you should cover. Fuel comes to mind first. But this isn’t the only cost.
Several states, including Massachusetts, Illinois, California, and Rhode Island, employ laws determining when employees should be reimbursed for company use of their cars. This further complicates the matter. For example, California’s mileage reimbursement rules state you have to pay reasonable costs in your car allowance. But what is reasonable?
Reasonable costs include operational expenses. When personal cars are also used for work, it results in increased fuel consumption and increased wear and tear. Not to mention more frequent tire changes, oil consumption, and other maintenance costs.
Finally, reasonable costs include ownership-related expenses. You’ll have to reimburse your employees for vehicle insurance, registration, depreciation, and taxes.
How to Calculate the Car Allowance or Mileage Reimbursement Amount
The best way to calculate a car allowance is to determine the average cost of owning and operating a vehicle in your state. How much is spent on gas, maintenance, insurance, etc.?
Then have a lawyer look at whether the car allowance you determine complies with state laws.
Another way to determine the amount you should pay on behalf of car allowance or mileage reimbursement is to use the IRS Standard Mileage Rate. This way, you’ll get a ballpark amount.
This is because the IRS Standard Mileage Rate represents the average yearly car expenses across the U.S. However, the IRS Standard Mileage Rate works great only if your employees drive about 14,000 miles yearly or if they don’t drive in costly parts of the country.
This is the main problem with using this approach. The IRS Standard Mileage Rate typically over-reimburses high-mileage employees and under-reimburses low-mileage employees.
The former scenario leads to higher company expenses, while the latter can lead to labor code violations.
If you have employees driving all around the country, Fixed-and-Variable Rate is the most accurate and fair method of reimbursement. However, the FAVR program is also the most challenging to implement.
Can the Government Tax Car Allowance and Mileage Reimbursement?
Yes, the government can tax company car allowance and mileage reimbursement. First, your typical car allowance is considered taxable income. This is because a car allowance doesn’t substantiate company use.
On the other hand, the mileage reimbursement program can be non-taxable if it doesn’t exceed the IRS Standard Business Mileage Rate.
However, remember that you’ll have to measure and report business mileage to prove that your mileage reimbursement is within the accountable plan or following the IRS’s standards.
Which Is Better: Car Allowance or Mileage Reimbursement?
Both car allowance and mileage reimbursement are popular since they’re simple to implement and understand.
However, their simplicity comes at a cost.
At first, a car allowance was a catch-all that covered vehicle costs and increased compensation without increasing the paycheck. But this was when fewer positions involved traveling by personal car.
At the time, the system worked. Now, not so much.
Today we have many professions where the vehicle is a de facto “office.” Just think about in-house caregivers, traveling sales agents, or even coders who often travel using their own vehicles. So now, our typical car allowance doesn’t cover all the costs associated with travel.
Under-reimbursing has become quite an issue. The government eliminating tax deductions for business mileage has only amplified the problem.
But even if you switch to the IRS Standard Mileage Rate, you’ll get different issues. For starters, you’ll have to watch out for cost control. Your employees can drive more to get more cash. Not to mention that at 65.5 cents per mile, the IRS Standard Mileage Rate becomes expensive quickly. Moreover, you may under-reimburse low-mileage employees.
Track Your Employee’s Mileage Precisely with Timeero
So, car allowance or mileage reimbursement?
We’ve already determined that mileage reimbursement has many advantages over a car allowance. Mileage claims are often tax-free. They’re fairer to all employees. Moreover, they’re a clear-cut program.
But you can make mileage claims even simpler and prevent fraud at the same time. How?
Using Timeero, you can rest assured all the business miles are being captured. The mobile app recognizes when an employee is driving while on the clock and starts tracking.
Timeero allows you to measure business mileage in real time. Using the Route Replay feature, you can know which path your employee took while driving for your company.
The breadcrumbing technology lets you see even more details, including location points with timestamps and speed.
The Segmented Tracking feature gives you even more data with a hands-off approach. If you opt for this feature, you will be able to see your employees’ workday at a glance, broken down into segments:
Business trips - distance covered and time
Time spent on locations or jobs.
With Timeero, you can avoid the costs of imprecise reports and acquire a clear image of your business travel costs.
For accurate reimbursement, you can easily generate mileage expense reports and share them with payroll software, such as ADP or QuickBooks.
But that’s not all Timeero offers regarding mileage tracking and reimbursement. The software also comes with:
Commuter Mileage. You can define the number of miles that is considered a commute. As commuter mileage is not reimbursable, Timeero will only record miles beyond that threshold and count them as business mileage.
Shortest Route. Timeero can show your employees the shortest path to their job destination.
Suggested Mileage. Timeero can compare the actual and the shortest route and inform you about the difference in mileage.
With such advanced mileage tracking features, you will streamline mileage reimbursement and improve your company’s and employees’ accountability when using business resources.
Natasa is a writer specializing in the IT and software industry with 6+ years of experience in content writing and online marketing. During that period, she wrote more than 1,000 articles and several ebooks. She majored in English language and literature and loves cats, sneakers, and candy. When she's not working, she's probably binge-watching Netflix.