Companies with a mobile workforce know how challenging it is to adequately reimburse their employees for business miles and keep their expenses under control.
Besides car allowance and mileage reimbursement, the two standard methods of vehicle expense refund, the FAVR plan, has been gaining recognition with employers.
The reasons for such attention are pretty straightforward - FAVR car allowance seems to provide employees with fair refunds. At the same time, it means significant cost savings for the employer.
We've gathered all the relevant info on FAVR car allowance so that you can consider its potential advantages and disadvantages and decide whether it could benefit your company and your employees.
What is FAVR?
FAVR car allowance is a procedure designed for companies to reimburse their employees for tax-free business-related use of their private cars.
FAVR stands for "fixed and variable" as this method of reimbursement compensates employee car costs by determining:
- 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 as neither distinguishes between expense types or uses rates based on local costs. If companies fail to consider these cost variations, in some instances, it can lead to inaccurate and unjust payments and can have costly outcomes.
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 program grounds its refund rates on employee zip code and the costs of using a standard vehicle - the one most suitable for the employee's job.
FAVR plan is a combination of mileage reimbursement and monthly allowance. 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 understand FAVR car allowance better, 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 amount 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 both FICA taxes for employers and income taxes for employees.
The tax-related math is not that simple, but it won't be a mistake if we say that you can lose from 30% to 40% to taxes. For example, out of the $500 you pay your employee for car allowance, it's only around $350 they will actually get. On top of it all, even those $350 will be taxable. And, under the current IRS rules, they can no longer deduct business miles to neutralize the taxation of their car allowance. So, they are, in fact, losing their income.
Plus, you can hardly determine the fair amount to reimburse your employees this way. Your employees' mileage differs, and so do their expenses - the odds are high 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-mile employees, you are risking a lawsuit, as they can claim to be underpaid.
Mileage reimbursement schemes, especially the FAVR car allowance program, are created to compensate the 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.
The company calculates the refund sum by multiplying their employee's mileage by the business's mileage 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 4 cents for a mile, starting from July 2022. The rate is now set to 62.5 cents per mile.
Even though it's straightforward and 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, standard mileage reimbursement can also lead to overpaying or underpaying employees. For more information on reimbursing your employees' expenses for business-related miles, read our Guide to Employee Mileage Reimbursement.
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 fuel and other related costs, such as registration or car maintenance, are higher in California, so are the reimbursement rates.
How To Calculate a FAVR Allowance?
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, as long as it meets the standard vehicle's particular values and age conditions.
The variable rate consists of variable costs of operating a vehicle, 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.
However, for the FAVR plan to be efficient, you must ensure you're keeping track of your employees' miles accurately. To get more info on how to do it properly, read our How to Track Mileage for Work: An A to z Guide.
How Do I Qualify For Tax-Free Car Allowance FAVR?
FAVR car allowance is a non-taxable plan, but only if the company follows the IRS-set rules.
Like any other payment, to qualify as non-taxable, FAVR reimbursement must cover a business cost. When refunding an employee for using a personal vehicle, the company must prove that the payment actually compensates for a business expense.
With GPS-powered mileage tracking software, such as Timeero, providing the IRS with adequate and accurate 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 certain age and value and setting a maximum standard vehicle cost for FAVR car allowance. For 2022 this cost is set to $56,100, so employees can be pretty flexible when it comes to 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 a case of a car accident.
Should My Business Switch to FAVR?
To qualify for 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 a FAVR plan if your company has:
- mobile or field workers in different states,
- the need for flexibility in terms of standard vehicles,
- high-mileage employees.
And if you worry about risk exposure and potential liability of your company, FAVR car allowance can be a good fit. As we've mentioned above, to be eligible for the refund, employees must prove that their insurance meets certain minimum requirements. This way you can rest assured employees' insurance will kick in first in the case of an accident.
FAVR car allowance can also be a key to attracting and retaining employees in certain professions, as they will know for certain they will be reimbursed fairly for each traveled mile.
However, FAVR is a bit more complex than other reimbursement solutions, so it is not that easy to implement. To be tax-free and under IRS rules, you might need professional guidance in setting up and maintaining the entire program.
Can Timeero Help Me Implement FAVR Car Allowance?
Whether you opt for standard mileage reimbursement or FAVR car allowance, Timeero is a reliable tool that makes refunding your employees for the business use of their private vehicle quite a breeze.
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.
No matter which method of reimbursement you choose, Timeero will provide valid and verifiable data. This way, you will avoid inaccurate reporting and ensure your company is always IRS-ready and compliant with the relevant legislation.
Thanks to the automation of the entire mileage tracking process, you will also cut down on administrative work and save time.
Furthermore, by giving you an insight into your employees' movements during their working hours, Timeero can help you hold your employees accountable for taking longer miles and controlling your expenses.
Start tracking miles with Timeero, and stop wasting your time and money!