The Tax Cuts and Jobs Acts reshaped the whole car allowance or mileage reimbursement question. Moreover, the tax reform removed all miscellaneous itemized deductions. Add to this the economic fallout of Covid-19 and increased inflation and it’s easy to see why companies have a hard time deciding whether to go with car allowance or mileage reimbursement.
If you don’t implement the right policies on car allowance and mileage reimbursement, your company is exposed to:
- Bigger expenses
- Lower efficiency
- Possible lawsuits or labor codes violations
All in all, employers now face more risks. Since you can’t write off car allowance or other unreimbursed costs, you face increased pressure to protect your margins. Fortunately, there’s light at the end of the tunnel. In this article, we’ll help you decide whether you should opt for mileage reimbursement or car allowance. Here’s how:
What is the Difference Between a Car Allowance and Mileage Reimbursement?
Well, with car allowance, you give your employees fixed cash rates for business use of their vehicles. Typically, the IRS can tax it. With mileage reimbursement, you pay back your employees a fixed cents-per-mile rate depending on how big their mileage count is.
If your mileage reimbursement is equal to or bigger than the IRS business mileage rate, you don’t pay taxes on it. To better understand both, let’s explore how car allowance and mileage reimbursement work:
How Car Allowance and Mileage Reimbursement Work
You pay car allowance to your employees to offset the company use of their personal automobiles. You can pay it either weekly, bi-weekly, or monthly as a part of their salary. Unfortunately, this also makes it taxable. With 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 $700 every month to cover these costs. Every month she gets the same car allowance regardless of how much she actually 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 have to track how many miles they drove for your business and provide precise cost reports. Using mileage tracker apps can help with accurately measuring mileage reimbursement (more on that later).
Keep in mind that the IRS specifies their 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 the year 2022, the IRS Standard Mileage rate is 58.5 cents per mile driven for company use.
On the other hand, some businesses decide to reimburse their staff lower or higher than the Standard Mileage Rate, based on whether the expenses tend to be 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 only going to the next city, other times visiting other states. His company pays him 59 cents for every mile he drives to visit 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 it’s more crucial than ever that you accurately reimburse your employees. Car allowance or mileage reimbursement, which way to go?
The Pros of Car Allowance vs Mileage Reimbursement for Employers
The best part of a car allowance is that you give your employees a fixed car allowance every month, regardless of how much they drove for your company. Why? Because it’s simple. And simple is easier to understand.
Plus you’ll spend less time thinking about it. Time management is a key entrepreneurial skill. 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.
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 of it 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. If their vehicle is based in states that levy income taxes, this amount is even smaller. 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 as cost reimbursements, your employees have to catch up with their income.
Moreover, even though you’ll easily report a car allowance to the IRS, you will increase your business’ FICA — Federal Insurance Contributions Act — tax liability a lot. 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 both income taxes for employees and FICA taxes for employers.
Fairness, Overpaying and Underpaying on a Car Allowance
When you compare car allowance and mileage reimbursement, it’s very hard 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 every day to visit various clients. While 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 in order 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 their cars see. Ultimately, you end up paying more for car allowances while actively motivated to spend less on business trips.
If your company has high-mileage employees, a car allowance introduces possible class-action lawsuits. This is because employees can claim they were underpaid.
When your team is based in various regions, their car expenses will vary a lot. This leads to more systemic imbalances. Furthermore, their car costs can vary from month to month. Fuel prices follow the market. Sometimes they go up, other times they fall. For example, let’s compare weekly retail prices of regular gas in different U.S. states in 2022:
- California: $4.68 per gallon
- Hawaii: $4.41 per gallon
- Washington: $3.96 per gallon
- Arkansas: $3.1 per gallon
- Indiana: $3.36 per gallon
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 accurately determine the right car allowance. 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.
Benefits of Mileage Reimbursement
When it comes to choosing between car allowance or mileage reimbursement, the math on the latter is also simple. You won’t have trouble calculating and using mileage rates. Plus mileage rates equal to or bigger than the IRS Standard Mileage Rate aren’t taxable. In fact, the main advantage of mileage reimbursement over car allowance is that you often don’t have to pay taxes for them.
If your employees keep a mileage journal or use a mileage tracking app for distance verification on car business use, 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 compared to 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, when it comes to mileage reimbursement or car allowance, it’s easy to go with the former.
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. Other disadvantages of mileage reimbursement include:
- Risks of labor codes 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.
Fortunately, you can avoid most of these problems with mileage tracker apps.
Allowance and Mileage Reimbursement Amounts
Before you can calculate your car allowance or mileage reimbursement, you’ll need to know what kind of expenses you should cover. Obviously, fuel comes to mind first. But this isn’t the only cost. For instance, gas represents only 16.7% of total average driving costs in 2020, according to the Bureau of Transportation Statistics.
Several states, including Massachusetts, Illinois, California, and Rhode Island, employ laws that determine when employees should be reimbursed for company use of their personal cars. This further complicates the matter. For example, California’s laws 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 costs. This means 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 take a 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 actually drive about 14,000 miles every year or if they don’t drive in particularly expensive 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. Still, if you’re low on time, this is one of the best approaches.
Can the Government Tax Car Allowance and Mileage Reimbursement?
Yes, the government can tax car allowance and mileage reimbursement. First, your typical car allowance is considered a taxable income. This is because a car allowance doesn’t substantiate company use.
On the other hand, mileage reimbursement can be non-taxable if it doesn’t go below the IRS Standard Business Mileage Rate. However, keep in mind that you’ll have to measure and report business mileage in order to prove that your mileage reimbursement is within the IRS’s standard.
Car Allowance or Mileage Reimbursement - Which is Better for my Business?
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 played a role of a catch-all that covered vehicle costs and increased compensation without actually 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 lots of professions where the vehicle is a de facto “office”. Just think about in-house caregivers, traveling sales agents, or even coders who travel a lot. So now, our typical car allowance doesn’t cover all the costs associated with travel. In fact, 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 a different set of issues. For starters, you’ll have to watch out for cost control. Your employees can drive more in order to get more cash. Not to mention that at 58.5 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 quite a few 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? With a mileage tracking app. It allows you to measure mileage in real-time and actually know which path your team took while driving for your company. You can avoid the costs of imprecise reports and acquire a crisp clear image of your business mileage costs.