Car Allowance Vs. Mileage Reimbursement? The Ultimate Guide
Andjelka Prvulovic
Last update on:
May 30, 2024 10:23 AM
Published on:
Choosing the wrong car allowance and mileage reimbursement policy can have severe consequences for your company, such as increased expenses, lower business efficiency, and possible lawsuits or labor code violations.
Employers now face more risks primarily because recent changes in tax laws have eliminated the ability to write off car allowances and other unreimbursed employee expenses.
This means companies can no longer deduct these costs, which directly impacts their bottom line. Additionally, stricter labor codes and regulations increase the risk of non-compliance, leading to potential legal issues and financial penalties.
Since you can’t write off car allowance or other unreimbursed costs, you face increased
pressure to protect your margins.
In this ultimate guide, we’ll help you decide whether to opt for mileage reimbursement or car allowance.
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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 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 on 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 a car allowance to your employees to compensate for the business use of their personal vehicles. This allowance can be paid weekly, bi-weekly, or monthly as part of their salary. However, because it is considered part of their regular pay, it is subject to income tax.
With a car allowance, you cover automobile costs such as:
Maintenance
Insurance
Depreciation
Fuel
Wear-and-tear
The key part is that with a car allowance program, the amount of cash paid stays the same each month, no matter how much employees actually drove for business purposes.
Let’s take a look at a real life example of using car allowance:
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 drives her car.
On the other hand, mileage reimbursement works just as it sounds—you reimburse your employees based on the number of miles they drive for company purposes.
Below is an example of using mileage reimbursement in the workplace:
Martin is a sales rep for a pharmaceutical company. He drives his personal car to visit new and old clients. Sometimes, Martin goes to the next city; other times, he visits other states. To be IRS-compliant, his company pays him 67 cents for every mile he drives to see clients.
For mileage reimbursement to work, your employees must track the miles they drive for work and provide precise mileage logs and cost reports. Mileage tracker apps like Timeero can help accurately measure business miles and streamline reimbursement.
The travel route and mileage record on the Timeero app.
Tax Implications of Car Allowances and Mileage Reimbursements
The IRS classifies vehicle allowances and mileage reimbursements into two categories:
Non-Taxable (Accountable Plans)
For reimbursements to be non-taxable, they must meet IRS guidelines for accountable plans. This includes providing a detailed IRS mileage log or justification of actual expenses, and ensuring the reimbursement does not exceed the IRS standard mileage rate.
Taxable (Non-Accountable Plans)
If the reimbursement cannot be substantiated, it is considered taxable income. This increases the employee's tax burden and the employer’s FICA liability.
Car Allowance vs. Mileage Reimbursement: Pros and Cons for Employers
Car Allowances: The Easy But Costly Option
A car allowance is a straightforward way to compensate employees for using their personal vehicles for business purposes. When you opt to pay out car allowance, you compensate your employees at a flat rate, regardless of how much they drive for your company.
For example, a small business with five employees who occasionally use their personal vehicles can opt for a $400/month car allowance and simplify their payroll process.
This method’s main advantage is simplicity, which means less hassle and confusion. You only have to decide how much the car allowance is and when and how your employees will get paid.
While the simplicity of car allowances is appealing, the impact it has on company finances and fair compensation can be significant.
Tax Waste
Car allowances are treated as taxable income, leading to a hefty tax burden. For an employee in the 24% tax bracket, a seemingly generous $500 allowance might shrink to around $350 after taxes. This hidden tax liability can make car allowances less attractive for employees, directly impacting their take-home pay.
Businesses also face a higher tax burden in the form of increased FICA taxes for each employee receiving a car allowance. This is because these allowances are classified as wages, not reimbursements, triggering additional employer-side payroll taxes.
Fairness, Overpaying, and Underpaying on a Car Allowance
Determining a fair car allowance is challenging. How do you know how much employees need to operate and own their vehicles?
It’s easy to overpay some employees and underpay others. Car allowances are a one-size-fits-all solution, which can be problematic if your employees have varying levels of business mileage.
For instance, if Mark drives 500 miles/month while Paul drives 2,000 miles/month, a $500 car allowance would overpay Mark and underpay Paul, leading to unfair allowance amounts.
You may set a higher car allowance to minimize the risk of under-reimbursing your employees. While this might seem generous, it can have unintended consequences. Some employees might be tempted to drive less than necessary for business purposes to pocket the excess allowance.
Take note: 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.
Additionally, high allowances can strain your budget and leave less room for other employee benefits or investments. It's important to consider these potential drawbacks when determining a car allowance amount.
Compliance Challenges
Some state labor codes, such as in California, require reimbursement for all reasonable business expenses, including fuel, maintenance, and wear and tear. A car allowance may not adequately cover these costs, potentially leading to non-compliance and legal risks.
To avoid these risks, it's crucial to understand the specific compliance challenges of car allowances in your state.
Mileage Reimbursement: Accountable and Fair Compensation
Is mileage reimbursement the better option for your company?
The main advantage of mileage reimbursement over car allowance is that it is tax deductible if you follow the IRS mileage reimbursement rules.
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.
Additionally, mileage reimbursements are more accurate. This means they provide fair compensation to all employees rather than giving everyone a fixed amount for vehicle use. There aren't any under- or over-payments to employees when mileage accruals vary in your company.
Tracking Requirements and Potential for Fraud
Reliable mileage tracking is essential for the mileage reimbursement program to be effective and compliant. Manual tracking can be error-prone and time-consuming. Without robust mileage tracking systems, employees may overstate their mileage, leading to unnecessary expenses for your company.
A common issue with mileage reimbursement is its potential for fraud, with employees submitting inaccurate mileage claims.
For instance, an employee might claim they drove 500 miles when they really drove 300, leading to overpayment. Such discrepancies increase costs, lead to trust issues, and potential fraud investigations.
Easily enforce your mileage tracking policy with Timeero.
To mitigate these risks, consider using a reliable mileage-tracking app like Timeero. Timeero simplifies the process by automating mileage tracking, which ensures accuracy, and reduces fraud.
How to Calculate Car Allowance or Mileage Reimbursement Amounts
Before calculating your car allowance or mileage reimbursement amounts, 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, have laws determining when employees should be reimbursed for company use of their cars, further complicating the matter.
Operational expenses. fuel consumption, wear and tear, frequent tire changes, oil consumption, and other maintenance costs.
Ownership-related expenses. Vehicle insurance, registration, depreciation, and taxes.
The best way to calculate a company 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.?
After you make this estimation, have a lawyer review the car allowance.
Another way to determine the amount you should pay for a car allowance or mileage reimbursement program is to use the IRS Standard Mileage Rate. This rate represents the average yearly car expenses across the U.S. For 2024, the IRS Standard Mileage Rate is 67 cents per mile driven for company use.
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.
The IRS Standard Mileage Rate typically over-reimburses high-mileage employees and under-reimburses low-mileage employees. The first scenario leads to higher company expenses, while the second can lead to labor code violations.
If you're looking for a reimbursement method that strikes a balance between the simplicity of car allowances and the accuracy of mileage reimbursement, Fixed and Variable Rate (FAVR) allowances might be the answer.
The FAVR method combines a fixed monthly payment to cover predictable vehicle costs (like insurance, registration, and depreciation) with a variable rate based on mileage to cover fluctuating costs (like gas and maintenance). It's a more tailored approach compared to the one-size-fits-all nature of traditional car allowances.
Let’s say Jane is a sales executive who drives extensively for her job. Her company uses the FAVR method to reimburse her. She receives a fixed monthly amount of $200 for insurance and registration and .50 cents per mile for variable costs. This approach ensures Jane’s reimbursement is closely aligned with her actual expenses.
Advantages of FAVR
Accuracy and Fairness. FAVR provides a more accurate and fair reimbursement because it reflects actual costs incurred by employees. This prevents overpayment or underpayment.
Tax Efficiency. Since FAVR plans align with IRS rules for accountable plans, reimbursements can be tax-free for employers and employees.
Employee Satisfaction. Employees feel more valued and fairly compensated for their specific expenses, leading to higher job satisfaction and retention.
Considerations for Implementing FAVR
Setup Complexity. Calculating the appropriate fixed and variable rates involves considering factors like vehicle type, local costs, and IRS guidelines. This requires more effort and resources compared to simpler reimbursement methods.
Compliance. Ensuring labor law and IRS compliance is crucial. Working with tax professionals or consultants can help you set up and maintain a compliant FAVR plan.
For companies with employees driving varying distances in different locations, the FAVR method can be a game-changer. And because it aligns with IRS rules, it can be tax-free for both the employer and employee, making it a win-win situation.
Track Your Employee’s Mileage Precisely with Timeero
So, now it’s decision time. Will you choose to issue a car allowance or mileage reimbursement for your employees?
We’ve already determined that mileage reimbursement has many advantages over disbursing a car allowance. Mileage claims are often tax-free and are a fair way to compensate all employees. Additionally, they’re a clear-cut method for covering personal vehicle use for business purposes.
But did you know that you can make mileage claims even simpler and prevent fraud at the same time.
How do you do this?
By streamlining time-consuming and error-prone tasks with a mileage-tracking app.
Timeero’s GPS Time Clock: Start Tracking Miles With a Single Click
When using Timeero you can rest assured that all business miles are being recorded. The mobile app recognizes when an employee is driving while on the clock and starts tracking mileage automatically.
You don’t have to worry if your employees travel to areas with weak or no internet connectivity, as Timeero tracks offline, too.
Timeero’s Route Replay: Revisit Employee Routes
Timeero allows you to measure business mileage in real-time. Using the Route Replay feature, you can see which path your employee took while driving for your company.
See the path your employee took.
Breadcrumb technology allows you to see even more in-depth details, including individual location points with timestamps and speed.
Timeero’s 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:
Distances covered during business trips
Time spent at locations and jobsites
With Timeero, you can avoid the costs associated with imprecise reports and acquire a clear image of your business travel costs.
Accurate Reimbursement With Timeero
Mileage report in Timeero.
To ensure accurate reimbursement, you can easily generate mileage expense reports and share mileage costs using payroll software integrations.
Timeero integrates with popular payroll software.
But that’s not all Timeero offers in regards to mileage tracking and reimbursement.
The software also contains the following features and functions:
Commuter Mileage
Easily deduct commute mileage with Timeero.
First, define the number of miles to be considered commuter mileage. According to the IRS, commuting mileage is not considered reimbursable; Timeero will only record miles beyond the defined commuting threshold as business mileage.
Shortest Route
Timeero mobile app can point your employees to the shortest route.
Show your employees the shortest path to their job destination.
Suggested Mileage
Timeero can compare the real route with the shortest route and show you the mileage difference.
Compare the actual and the shortest route and calculate the difference in mileage.
With these advanced mileage tracking features, streamlining mileage reimbursement and improving company and employee accountability is simple. To discover how Timeero can benefit your business, read our Timeero review.
Disclaimer: This article provides general information about car allowances, mileage reimbursement, and FAVR. It is not intended as a substitute for professional legal or financial advice. Laws and regulations vary by jurisdiction, and consulting with qualified professionals is essential to ensure compliance with applicable laws and regulations.
Car Allowance VS. Mileage Reimbursement: FAQ
What is the difference between allowance and reimbursement?
An allowance is a fixed amount paid regularly to cover vehicle expenses and is taxable as income. Mileage reimbursement is a variable amount paid based on actual miles driven and is non-taxable if within IRS guidelines.
How do you calculate mileage reimbursement versus a car allowance?
You can calculate mileage reimbursement manually by multiplying the miles driven for business purposes by the IRS standard mileage rate. We recommend using a reliable mileage tracking app, such as Timeero to calculate mileage reimbursement. Car allowance is determined by setting a fixed monthly amount based on estimated average vehicle expenses, such as fuel, maintenance, and insurance.
How do car allowances compare to mileage reimbursements in terms of tax implications for employees?
Car Allowances are generally taxable, increasing the employee's taxable income and the employer’s FICA liability. Mileage Reimbursements are non-taxable if substantiated and within IRS guidelines.
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.
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