Team Cardata

Sep 10, 2024

20 mins

A guide to turning a taxable allowance into an accountable allowance

Car Allowance

Vehicle reimbursement options

Vehicle reimbursement can be tricky for businesses, especially when they’re trying to balance employee satisfaction with cost efficiency. From car allowances to more complex reimbursement plans, each option has its own tax implications and compliance rules. Whether you’re a small business owner, an HR professional, or a finance leader, understanding these differences is important for optimizing your company’s approach to business-related expenses.

This guide explains how to transition from a taxable or non-accountable car allowance to an IRS accountable allowance. An accountable allowance is any type of car payment – be it a flat allowance, a fixed and variable payment, or a per-mile rate – that meets the IRS’s criteria for expense substantiation and can be paid partly or completely tax-free. It will cover all forms of accountable allowances, but it will focus on the tax-free car allowance, a type of vehicle benefit that combines the simplicity and flexibility of a car allowance, with the tax benefits of mileage logging.

Why the transition from taxable to accountable allowances matters

Switching from a taxable, in-house car allowance to an accountable allowance is a straightforward step businesses can take to reduce their tax burden. Taxable allowances, while easy to run, are considered taxable income and increase both payroll taxes and income taxes for your employees – which they typically do not appreciate. Accountable plans, when done properly, are considered tax-free reimbursements, reducing both income tax and payroll tax deductions for your company and employees.

The IRS outlines clearly what constitutes an accountable plan, and how meeting their requirements can lead to big tax savings. By requiring substantiation of business mileage or car expenses, accountable allowances ensure compliance with IRS regulations while minimizing excess reimbursements and protecting both the company and employees from unnecessary tax loss.

In this guide you will find:

1. Definition and differences: Detailed explanations of both taxable and accountable allowances, as well as the tax implications of each under IRS regulations.

2. Types of accountable allowance: A closer look at the different types of accountable allowance, including dollar-for-dollar reimbursement using the actual expenses method, as well as cents per mile, tax-free car allowance, and fixed and variable rate (FAVR) reimbursement programs.

3. Accountable allowance rules and best practices: An overview of the IRS rules and company-level best practices for launching and administering an accountable allowance

By the end of this guide, you’ll have a clear understanding of vehicle reimbursement options and how to align them with your company’s goals and IRS requirements.

Definition and Differences

What is a taxable allowance

A taxable car allowance is a set amount of money provided to employees to cover the costs of using their personal vehicle for business purposes. Unlike accountable plans, this type of allowance does not require employees to substantiate their car expenses or business mileage, making it subject to income tax and payroll taxes. It’s considered part of the employee’s gross income and must be reported on their tax return.

Why is it seen as taxable income

Under IRS regulations, any reimbursement that is not tied to a documented business expense is treated as taxable income. Since taxable allowances are not substantiated by mileage logs or receipts, they are considered “nonaccountable” and are therefore fully taxable. This means that both the employer and the employee are liable for employment taxes on these payments.

Why pay a taxable car allowance

Taxable car allowances are common in industries where employees regularly use their personal vehicles for business travel. For example sales, delivery, and other field services. Businesses often choose this option for its simplicity, as it eliminates the need for expense recordkeeping or mileage reimbursement documentation. However, this simplicity comes at the cost of higher tax liabilities and missed opportunities for tax exemptions or tax deductions on business-related expenses.

What are accountable allowances

An accountable allowance is any allowance that meets the IRS’s guidelines for business expenses in publication 463. Under an accountable plan, employees must provide substantiation of their business mileage or car expenses through either detailed mileage logs or expense reports. On most types of accountable allowance, the reimbursement amount that employees receive is limited to their business mileage multiplied by the IRS standard rate or to the sum of their actual car expenses for business use. Any excess reimbursement above this amount must be returned to the employer or taxed as regular income.

Differences from taxable allowances

The primary difference between an accountable allowance and a taxable one is the need for business expense substantiation. Employees can do this through the actual expenses method, where they submit receipts for their actual vehicle expenses such as an oil change or a tank of gas, or through business mileage logs. In practice, virtually all accountable allowances use mileage logs because of the difficulty of tracking actual expenses and associating them with business driving.

Benefits of switching from taxable to accountable

Transitioning to an accountable allowance offers serious tax savings for both the employer and the employee. By complying with IRS regulations, businesses can reduce their payroll taxes and employees can avoid paying income tax on their reimbursements. This approach also aligns with best practices for managing employee business expenses, as IRS mileage logs clearly assign spend to specific business activities.

Types of IRS Accountable Allowance

A look at different reimbursement methods

While it sounds like a specific type of car allowance, “accountable allowance” is actually an umbrella term for any form of allowance that satisfies the IRS’s requirements for non-taxable reimbursement. Companies can structure their accountable allowance in a variety of ways, so long as they meet the requirements for business connection, substantiation, and return of excess reimbursement laid out in publication 463.

Actual expenses method

The actual expenses method is the most basic form of accountable allowance. It requires employees to claim the exact costs they incurred while using their personal vehicle for work. This includes fuel, maintenance, insurance, and other regular car expenses. Typically, these claims are submitted through an expense management platform like Concur, reviewed by managers, and then reimbursed dollar-for-dollar once they are approved.

Pros and Cons

In theory, the biggest advantage of the actual expenses method is that it provides more accurate reimbursement for the true costs of business driving. However, the downside is the tedious and meticulous recordkeeping burden it places on employees. Every single expense must be documented, and the process of calculating the deductible portion of each expense can be really challenging and time-consuming. Additionally, because this method only works with very thorough substantiation, it can be challenging to meet the IRS’s strict requirements and rules.

Because of these drawbacks, almost all accountable allowances substantiate using mileage rather than their actual expenses.

Mileage-based reimbursement options

Mileage reimbursement is the most common method businesses use to compensate employees for vehicle use. On a mileage-based accountable plan, employees substantiate their expenses by tracking the miles that they drive for business rather than tracking their expenses directly. When mileage is properly logged, these programs give drivers a tax benefit that is at least equal to what they would have received at the IRS standard rate.

Importantly, this benefit exists no matter how the driver’s payment is structured. More on that in the sections below.

The IRS Standard Rate

The IRS standard rate is a value set by the IRS every year up to which drivers can be reimbursed without being taxed. It is a safe harbor rate for business driving that is designed to cover the average cost of fuel, maintenance, depreciation, and other car-related expenses for occasional drivers. The standard mileage rate for business use was $0.67 per mile in 2024 a 1.5 cent increase from 2023.

IRS criteria for mileage reimbursement

To meet IRS regulations, mobile employees must keep detailed mileage logs that include the date, destination, purpose of the trip, and the number of miles driven. Accurate recordkeeping means that the mileage reimbursement qualifies as tax-free. The IRS requires that these records be contemporaneous, which is just a fancy way of saying “up-to-date”.

Cents per Mile Program

The most straightforward accountable allowance is a cents per mile (CPM) program. In a CPM program, employees are paid a set amount per business mile. This rate is often the IRS standard rate but does not need to be. As long as the mileage rate that drivers’ receive does not exceed the current IRS standard rate, it can be paid entirely tax-free.

This means that CPM payments are tax-free at source, drivers never need to return excess reimbursement and are never assessed for tax retroactively. Since the payouts that drivers receive are directly tied to eligible business mileage, “excess reimbursement” is not possible. This makes CPM programs conceptually similar to dollar-for-dollar reimbursement, except that they use an assumed cost per mile instead of actual driving expenses.

This program is particularly useful for companies because it simplifies the reimbursement process and can easily work within the IRS’s standard mileage rate rules.

Pros and cons

The main benefit of CPM programs is their ease of use. The constant rate of reimbursement and lack of additional compliance measures make administering a CPM program very easy.

The main drawback of CPM programs is that per-mile rates do not accurately reflect driving costs, especially at high mileage. As a result, they are a notoriously bad fit for high mileage drivers who can receive absurdly high payouts on the program.

A good rule of thumb is to only consider CPM programs for employees who drive fewer than 5,000 business miles per year.

Tax-Free Car Allowance (TFCA)

Under a TFCA, employees are paid a flat monthly stipend for their business driving. However, unlike a regular car allowance, a TFCA combines this payment with mileage logging to substantiate part or all of the allowance as a tax-free reimbursement.

On a TFCA, payments are tax-free up to what each employee would have received at the IRS standard rate. This amount is called the non-taxable limit. Any amount above this limit must be taxed as regular income retroactively.

This is easiest to understand with an example. Say an employee is paid a $500 allowance and drives 800 miles in a given month, and the current standard rate is 67 cents per mile. That employee has received $500 but has a nontaxable limit of $536 ($0.67 per mile times 800 miles). Because their reimbursement is lower than their tax-free limit, they are 100% nontaxable.

But, if that same driver drove only 700 miles, their nontaxable limit would be only $469 ($0.67 per mile times 700 miles). As a result, the first $469 of their allowance would be deemed nontaxable, and they would owe tax on the remaining $31.

The IRS guidelines suggest applying this taxable income test quarterly.

Pros and cons

The primary benefit of this reimbursement method is its simplicity; it provides predictable, regular payments to drivers while capturing the tax benefits of an accountable program. TFCAs are most popular for companies that are transitioning away from a taxable allowance. By simply adding mileage tracking, a company can convert an existing flat allowance into a TFCA and realize significant savings.

Like CPM programs though, it may not always reflect the actual costs incurred by employees, especially if their business mileage is high or if it varies significantly month-to-month. Another drawback is that TFCA programs also have the potential for over-reimbursement, which creates an additional administrative burden in the form of a quarterly tax true-up.

Fixed and Variable Rate (FAVR) Program

The Fixed and Variable Rate (FAVR) program is a more sophisticated method of reimbursing employees for their personal vehicle use. As its name suggests, FAVR includes a monthly fixed rate and a per-mile variable rate. Importantly, these rates are personalized and data-driven. They reflect the true cost of driving based on each employee’s location, role, and mileage.

Below are the fixed and variable costs that go into FAVR calculations. This is the information that you have to gather in order to calculate your FAVR program rates as outlined by the IRS.

Fixed expenses for which FAVR reimburses:

Depreciation or lease payments
insurance premiums,
license and registration fees,
personal property taxes

Variable expenses for which FAVR reimburses:

Fuel prices,
oil changes,
tires,
routine maintenance,
Repairs.

This program makes sure that employees are fairly compensated for both the fixed and variable expenses associated with business travel. It is also 100% tax-free for compliant drivers. This is true even if FAVR reimbursements exceed what drivers would have received at the standard rate.

Benefits of FAVR

One of the numerous selling features of the FAVR program is that it can be tailored and crafted to reflect the specific costs incurred by each mobile employee, which means a more accurate and equitable reimbursement. FAVR must comply with IRS guidelines to ensure that reimbursements remain tax-free. This includes maintaining detailed records of vehicle costs and mileage but is not limited to it. If you follow the IRS rules of FAVR, this vehicle program can be reimbursed over the IRS standard rate while remaining tax-free.

Using company cars

Providing company cars is a common alternative to paying a cash allowance. In this arrangement, the company owns or leases and maintains the vehicles and covers all associated expenses. Employees are expected to use their cars primarily for business travel and the company assumes responsibility for most car-related costs.

When this might be suitable

Company cars might be suitable for businesses where vehicle branding, consistency, and control over vehicle conditions are major priorities. They are less advantageous when the goal is simply to provide a cost-effective benefit to employees. While company car programs offer the highest level of control, they also come with the most significant financial and operational costs, including acquisition, maintenance, insurance, liability, depreciation, and disposal. Their tax treatment can also be complex.

Accountable allowance requirements and best practices

Specific requirements of an accountable plan

For a plan to be considered accountable, it must meet three main criteria, as outlined in Publication 463:

business connection, substantiation, and return of excess payments. The reimbursement must be for business-related expenses, employees must substantiate the expenses within a reasonable period of time, and any excess reimbursement must be returned. [5] In practice, reimbursements are rarely returned on accountable plans. Instead, they are retroactively treated as taxable income. The guidelines provided in Publication 463 suggest applying these taxes quarterly.

Compliant mileage records

Accurate mileage tracking is essential for maintaining an accountable plan for vehicle reimbursements. The IRS requires that employees maintain contemporaneous — again, this just means “up to date” — mileage logs that document the date, purpose, and distance of each trip that was made for business reasons. These records are necessary for substantiating the reimbursement and ensuring tax-free status. Instead of maintaining manual logs, most companies choose to use a mileage tracking app that can automatically record the required information.

How to transition from a taxable to an accountable plan

Communicate the upcoming change to employees
1. Clearly explain the transition to an accountable plan and how it differs from the previous taxable one.
2. Highlight the benefits, including potential tax savings and the importance of accurate recordkeeping.
Update reimbursement policies
1. Revisit your company’s reimbursement policies to make sure they align with IRS requirements and the company’s goals.
2. Set clear guidelines for documentation and substantiation, like what qualifies as a business trip and how to properly document it.
Provide training and tools.
1. Offer training sessions to help employees understand the new requirements.
2. Provide tools, like mileage tracking apps or expense management software, to help employees adapt to the new processes.

Updating your policies and implementing a new plan

When switching to an accountable plan, it’s important to review and update your company’s reimbursement policies. This might mean defining the types of trips that qualify for reimbursement, setting limits on reimbursement amounts, or creating guidelines on the type of vehicle that employees are expected to drive. Implementing these changes may require coordination with the finance and HR departments as they may require updates to your company’s payroll, HRIS and accounting systems to ensure that reimbursements are properly recorded.

Automating substantiation

Consider investing in tools that streamline substantiation, like a mileage tracking app that automatically creates compliant mileage logs from employee trips or software platforms that integrate with your other expense systems.

Training for employees on the new program

Consider providing training sessions that help employees understand the new policies and offer ongoing support to address any questions or concerns. If your employees are well-informed and equipped with the right tools, this will help facilitate a smooth transition to the new reimbursement plan.

Benefits of Accountable Allowances

Tax savings win-win for employer and employee

One of the strongest reasons to switch to an accountable plan is the tax savings. Reimbursements that are substantiated under an accountable plan are not considered taxable income, meaning that employees and employers are exempt from income and payroll tax deductions. This dual benefit of tax-free reimbursements helps minimize overall tax liability and puts more money in the pockets of companies and employees

Reallocating funds elsewhere

By avoiding the tax waste that comes with non-accountable plans, businesses can allocate resources more effectively, ensuring that every dollar spent on employee reimbursements is maximized. This not only improves the company’s bottom line but also shows a commitment to fair compensation for business-related expenses.

Improved fairness and equity

Switching to an accountable allowance plan can lead to a fairer, more equitable outcome for employees, who will no longer be taxed on reimbursement for an undocumented business expense. This is especially true if the transition involves moving from a flat allowance to a hybrid model that includes a per-mile rate.

By providing tax-free reimbursements that more accurately reflect the costs employees incur on the job, companies show a commitment to fairness and boost employee satisfaction. Employees who feel fairly compensated are also more likely to stick around with the company, reducing attrition.

Common Pitfalls and Challenges

Common challenges during the transition

Employees may struggle with tracking their business mileage or with meeting new compliance requirements on more complex programs like FAVR. This is especially true without the assistance of software. If clear plans and policies are not established before moving to a new plan, administrators may find it difficult to answer employee questions or support them through the transition.

Ensuring a smooth transition

To ensure a smooth transition to an accountable plan, clearly communicate with your mobile team, thoroughly document your policies, and provide ongoing support for anyone who needs it. Providing resources like mileage tracking apps and expense management software can also ease common stressors for administrators and employees, as well as streamline the process and reduce errors.

Quantifying the Benefits

What a company adopting an accountable allowance can expect

Companies that implement accountable plans often see significant financial benefits. Companies can save up to $2600 in total taxes per employee annually, based on the national average car allowance [7].

Tools and Resources

Automated tracking applications

There are lots of software solutions available that can help companies automate the process of mileage tracking and documentation. These tools usually include features like GPS-enabled mileage logs and integration with other business systems, making it easier to maintain compliant records and streamline the reimbursement process. [8]

Special features of these tools

The best mileage tracking apps offer features like automatic trip detection, customizable reporting, and easy integration with other HR systems. For example, some apps use GPS technology to accurately track business mileage, reducing the need for manual tracking and minimizing errors. Other tools offer real-time syncing with other expense management tools so that all reimbursements are properly documented and logged within your company’s systems.

FAQs

“How can we structure our car allowance program to minimize tax waste while also maintaining compliance with IRS regulations?”

To maximize tax efficiency, try to implement an accountable plan that adheres to IRS guidelines. Establish clear policies for substantiation. Utilizing tools like mileage tracking apps, or leveraging a fully-managed reimbursement provider can make this easier. You can also consider a Fixed and Variable Rate (FAVR) reimbursement program for further tax savings.

“How can we transition from a taxable car allowance to an accountable one with minimal disruption and maximum employee buy-in?”

We encourage you to engage with key stakeholders, including your finance, HR, and legal teams, to develop a change management plan that aligns with your business objectives. Communication is key, so prepare a detailed rollout plan that includes employee education sessions, FAQs, and one-on-one support. Providing smart e-tools like mileage tracking apps, as well as clear guidelines and documentation, will also help to smooth the transition and ensure employees understand what’s in it for them.

“What impact does transitioning to an accountable plan have on our payroll processes?”

Transitioning to an accountable plan affects payroll processes by shifting certain reimbursements from taxable income to non-taxable. So work closely with HR, finance, and payroll teams and coordinate the update to the necessary systems, as well as train payroll employees to note the changes, as well, thereby minimizing any downtime.

You can also avoid payroll issues by partnering with a reimbursement partner like Cardata. On a managed reimbursement program, Cardata can pay your employees tax-free by direct deposit.

“What are the risks of non-compliance with IRS rules and regs and how can we mitigate these risks?”

Non-compliance with the IRS can lead to financial penalties, increased audit risk, and potential back taxes for both the company and employees. You can mitigate these risks by establishing internal controls, including regular reviews of mileage logs and expense reports, clear communication of reimbursement policies, and ongoing training for employees and managers.

Conclusion

We explored the different aspects of vehicle reimbursement, from the different methods available to the benefits of accountable plans. We’ve discussed how transitioning to an accountable plan can lead to significant tax savings, improved compliance with IRS regulations, and better employee satisfaction. By understanding the ins and outs of an accountable plan and the steps involved in setting one up, businesses can make informed decisions that benefit both the company and its mobile employees.

Call to Action

If you’re ready to take the next step toward implementing an accountable plan, or if you have questions about how to optimize your current reimbursement program, Cardata is here to help. Our experts can guide you through the process, ensuring that your plan is compliant, efficient, and beneficial for all parties involved. Contact us today!