FAVR car allowance is a procedure designed for companies to reimburse employees for tax-free business-related use of their own cars.
FAVR stands for "fixed and variable," as this method of reimbursement compensates employee car costs by determining the following:
the ﬁxed, localized expenses such as depreciation, insurance, or registration, and
variable expenses such as maintenance, gas, or oil.
FAVR car allowance is quite different from a standard car allowance and mileage reimbursement. Unlike these two methods, FAVR car allowance distinguishes between expense types and uses rates based on local costs.
If companies fail to consider these cost variations, in some cases, it can lead to inaccurate and unjust payments and can have costly outcomes.
How Does FAVR Work?
The FAVR car allowance combines a ﬁxed payment to cover the costs of owning a vehicle with a variable rate that changes with employees' expenses.
FAVR car allowance combines mileage reimbursement and monthly allowance. This method grounds the refund rates on the employee's zip code and the costs of using a standard vehicle - the one most suitable for the employee's job.
As employers may tailor their payouts to fit each employee's location-specific costs and actual monthly mileage, such a system guarantees accurate and equitable payments.
To better understand the FAVR vehicle program, we will explain how it differs from the other two common methods - standard car allowance and mileage reimbursement.
Car Allowance vs. FAVR Reimbursement
A car allowance is the easiest method to cover the employee's expenses for using a personal car for business. Using a car allowance method, you pay your employees a fixed rate every month, regardless of how many miles they drove for your company.
But being less complicated doesn't make a car allowance an ideal solution. First, you must know that car allowance is not tax-deductible, which means it is subjected to FICA taxes for employers and employee income taxes.
The tax-related math is not that simple, but it won't be a mistake if we say you can lose from 30% to 40% to taxes. For example, out of the $500 you pay your employees for car allowance, they will most often get less than $350.
On top of it all, even those $350 will be taxable. And, under the current IRS rules, employees can no longer deduct business miles to neutralize the taxation of their car allowance.
So, your employees are, in fact, losing their income.
Plus, you can hardly determine the fair amount to reimburse your employees this way. Your employees' mileage and expenses differ - the odds are that you will end up underpaying or overpaying some of them.
In the best scenario, you will motivate your employees to drive fewer miles, as this will keep more money in their pockets. And when it comes to the high-mileage employees, you risk a lawsuit, as they can claim to be underpaid.
Mileage reimbursement schemes, especially the FAVR car allowance program, are created to compensate employees fairly for their expenses.
Mileage Reimbursement vs. FAVR Car Allowance
When an employer chooses a standard mileage reimbursement program, mobile employees must track the mileage when using their vehicle for business purposes. To get their refund employees need to submit that data to their employer to get their refund.
The company calculates the refund amount by multiplying their employee's mileage using the cents-per-mile rate. To be eligible for tax-free reimbursement, a company must use the IRS mileage rate, which this body determines towards the end of each year.
However, due to the recent increases in gasoline prices, the IRS has increased the reimbursement rate by 3 cents for a mile, starting from January 2023. The IRS mileage rate is now set to 65.5 cents per mile.
So, even though it's easy to use, such a reimbursement plan is a one-size-fits-all solution.
As it may not account for changing prices and is not sensitive to regional differences, the IRS standard mileage rate can also lead to overpaying or underpaying employees.
Many companies, especially those with team members from different regions, prefer the FAVR plan. FAVR car allowance uses location-specific rates, so it regards differences in employees' costs.
For example, if an employee uses their vehicle for business-related purposes in California, their FAVR mileage reimbursement rate will differ from an employee in Georgia. As the gas prices and other related costs, such as registration or car maintenance, are higher in California, so are the reimbursement rates.
FAVR car allowance is tailored to fit the employee's location and vehicle type, so it accurately mirrors employee costs.
The variable amount, which depends on mileage, is just a part of the total reimbursement. The fixed part of the payment that covers the ownership expenses does not change, no matter how many miles an employee drives.
Such a combination means less budget fluctuation and under-or over-compensations.
You can calculate the fixed part of FAVR reimbursement by adding the fixed vehicle ownership costs, including
depreciation for the standard vehicle,
license and registration fees in the state,
insurance rates for "standard vehicle" in the employee's zip code,
personal property taxes for the "standard vehicle."
The fixed part is calculated annually and then split by twelve to determine the monthly payment.
It's important to mention that you can set different standard vehicles for different employee groups to meet your company's budget and benefits goals.
Also, employees can choose any car they want if it meets the standard vehicle's particular values and age conditions.
The variable rate consists of variable vehicle operating costs, which vary based on location and vehicle type. These variable costs include
costs of fuel in the employee's area,
tire prices for the standard car,
oil changes, and other routine maintenance costs for the standard vehicle.
Variable rates are updated periodically to mirror fuel prices. You can calculate the variable part of FAVR reimbursement by multiplying the variable rate by the number of miles an employee drove during that period.
To understand the issue better, look at an FAVR car allowance example.
Say we want to determine the FAVR allowance for driving an average vehicle, 1000 miles per month, for business purposes in Arizona in 2023.
The IRS's cap for the standard vehicle in 2023 is set at $60,800. But let’s suppose that the actual value of a car an employee uses for business purposes is about $30,000.
What would our example calculation look like?
Fixed Costs include costs like insurance, license fees, and depreciation. The average annual cost for car insurance in Arizona in 2023 is $1,810 for full coverage. Let’s assume license fees and other fixed costs to be $500 (this is a hypothetical number as actual costs can vary).
Variable costs include expenses like fuel prices and maintenance. The IRS has set the business standard mileage rate at 65.5 cents per mile for 2023. You can use this rate instead of determining the amount of variable expenses deductible as business expenses.
Now let’s do the math:
Fixed Costs per Month:
Depreciation. Let’s assume a straight-line depreciation over five years. So, $30,000 / 5 / 12 = $500
Insurance:$1,810 / 12 = $150.83
License and other costs: $500 / 12 = $41.67
Total Fixed Costs per Month = $500 + $150.83 + $41.67 = $692.50
Variable Costs per Month:
1000 miles per month at the standard IRS rate of 65.5 cents per mile: 1000 * $0.655 = $655
So, the total FAVR allowance would be:
Fixed Costs per Month + Variable Costs per Month
$692.50 + $655 = $1,347.50
Remember that this is a simplified example. Actual calculations may vary based on factors like actual costs, IRS guidelines, company policies, etc.
How Do I Qualify for Tax-Free Car Allowance FAVR?
FAVR car allowance is a non-taxable plan, but only if the company is IRS-compliant.
Like any other payment, FAVR reimbursement must cover a business cost to qualify as non-taxable. When refunding an employee for using a personal vehicle, the company must prove that the payment actually compensates for a business expense.
With a GPS-powered mileage tracking app, such as Timeero, providing the IRS with adequate and accurate mileage logs and records is relatively straightforward, as companies can now easily distinguish between private and business-related miles.
What makes FAVR specific is using cost data for the standard vehicle regarding the employee's geographical location.
IRS guidelines require using vehicles of a certain age and value and setting a maximum standard vehicle cost for FAVR car allowance. As mentioned above, this cost is set to $60,800, so employees can be pretty flexible regarding the vehicle to generate reimbursement.
To qualify for FAVR car allowance, the IRS guidelines also demand that employees pay specific insurance coverage. Such a practice also protects the company from liability in the case of a car accident.
Summing It Up: What Are the Benefits of the FAVR Allowance?
The FAVR car allowance offers several benefits for employers and employees. So, we’ve summarized the five main benefits of the FAVR car allowance for you.
Tax-free compensation: Unlike standard allowances, FAVR allowances are not taxable.
Fair and accurate reimbursement: FAVR allowances reflect the actual costs of owning and operating costs, such as gas, insurance, maintenance, and depreciation. This way, employees are paid more accurately based on location and vehicle type.
Cost savings and flexibility: FAVR car allowance eliminates tax waste and gives employers greater flexibility and more control over how they use the funds over time. Plus, there is no need to own and maintain company cars, meaning fewer costs and trouble.
Compliance: FAVR allowances comply with IRS tax rules and state labor codes, which protect employers from audits and lawsuits.
Compettetivnes. FAVR car allowance can also be a key to attracting and retaining employees in certain professions, as they will know for sure they will be reimbursed fairly for each traveled mile.
However, FAVR is a bit more complex than other reimbursement solutions, so it is not easy to implement. To be tax-free and under IRS rules, you might need professional guidance in setting up and maintaining the entire program.
Should My Business Switch to FAVR?
To qualify for the FAVR car allowance, your company must have a minimum of five mobile employees conducting more than 5,000 miles for business-related purposes yearly.
If your company doesn't meet these minimum requirements, standard mileage reimbursement is still your best option to reimburse your employees fairly.
Furthermore, you will benefit from switching to an FAVR plan if your company has:
mobile or field workers in different states,
the need for flexibility in terms of standard vehicles,
And if you worry about your company's risk exposure and potential liability, FAVR car allowance can be a good fit. As mentioned above, employees must prove that their insurance meets specific minimum requirements to be eligible for the refund. This way, you can rest assured employees' insurance will kick in first in the case of an accident.
Can Timeero Help Me Implement FAVR Car Allowance?
Whether you opt for standard per-mile reimbursement or FAVR car allowance, Timeero is a reliable tool that makes refunding your employees for the business use of their own vehicles quite a breeze. The app gives you exact data on your employees' business mileage so your calculations can be accurate and fair.
This easy-to-use software will track your employees' mileage and streamline the entire mileage reporting process with a single click on their mobile phones.
Timeero will provide valid and verifiable data on your employees’ business mileage no matter which reimbursement method you choose. This way, you will avoid inaccurate reporting and ensure your company is always IRS-ready and compliant with the relevant legislation.
With the reports on employees’ business mileage ready in seconds, you can easily run the reimbursement using Timeero’s integrations with some of the most popular payroll software, such as ADP, QuickBooks, Rippling, Gusto, Paychex, and more.
But that’s not everything Timeero has to offer regarding mileage. There are some other mileage-related features that can come in handy, as they can help you use your resources more efficiently: save on time and fuel costs.
Let’s take a look at Timeero’s Shortest Route feature as an example. Using Timeero, you can create a job, specify a location, and assign or schedule it to your employees.
All your employees need to do is click the directions button, and the app will point them to the shortest route to the job site.
Timeero’s Suggested Mileage feature will provide you with even more details on how cost-efficient your employees are when it comes to choosing their traveling paths. The feature compares the actual mileage with the shortest route, and the difference between these two can paint a clear picture of your employee’s mileage accountability.
And, if you’re in for even more details on your field employees’ business travel and other work-related activities, the Segmented Tracking feature will provide you with a clear overview of your employee’s workday.
Furthermore, by giving you a timeline of your employees' movements during their working hours and locations they’ve visited, Timeero can help you hold your employees accountable for both their time and miles, helping you gain control over your expenses.
Thanks to the automation of the entire time and mileage tracking process, you will not only have accurate mileage data for reimbursement but also cut down on administrative work and save time.
Moreover, neither you nor your employees need to worry about intruding on their privacy - Timeero tracks business mileage during working hours only. And it does so accurately even in areas with poor or no internet connectivity so that no miles will be lost.
You can learn more about other notable features of the software and how it can help your business thrive by checking out our Timeero review. We’ve also tested and compared some of the best mileage-tracking apps so you can see what’s offered on the market.
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.