Are flat rate car allowances outdated? You could be overspending

Are car allowances a thing of the past?

Giving employees an auto allowance is a traditional way of paying employees to use their own vehicle for work. It is a fixed sum paid monthly to an employee together with their salary.

Businesses are at liberty to determine the value of an allowance. There are no limits or minimums to what can be paid as a car allowance.

Car allowances are suboptimal as business vehicle programs. They are heavily taxed and unfair to drivers. FAVR programs, discussed below, are a far better choice.

The pros and cons.

Pressed for time? This concise table lists the pros and cons of car allowances.

Pros

1. Empowers employees to use their own vehicle for work
2. Reduces company liability compared to company cars

Cons

1. It is treated and taxed like a salary
2. Has no relationship to the actual costs of driving
3. Disincentivizes driving if the allowance runs out

Alternatives

1. Fixed and Variable Rate (FAVR) reimbursement programs
2. All the pros of car allowances, and much more

1. CPM standard rate reimbursements
2. Fleets of company-owned or leased vehicles

Read on to learn more about these pros and cons—and about one common myth about allowances!

Pros

1. Employees use their personal auto

The vehicle allowance is meant to cover the costs of monthly car expenses for vehicles employees lease or own. It enables them to drive their personal vehicle for work. It provides them with a monthly payment, added to their salary, designed to cover all the car expenses on the vehicle of their choice.

Whereas company car or fleet programs provide the same or similar cars to all employees, car allowances allow drivers to select their ideal car. They can base their decision on the needs of their family, their image and personality, etc.

Companies sometimes do set policies for vehicle aesthetics. Nevertheless, with car allowances, employees have more flexibility in selecting the make, model, and trim of their vehicle.

2. Compared to fleet, liability is reduced

Allowance programs also reduce company risk by avoiding company car programs, which assign 24-hour liability to the employer. If a business owns company cars that employees drive home in the evenings and on the weekends, they are exposed to significant insurance risks.

Even when the employee is driving the company car for pleasure on the weekend, the business is liable for damage or injury caused by that vehicle, according to the Horton Group.¹ Even when an employee acts recklessly with the vehicle, the company is responsible for damages so long as they are the primary on the insurance policy.

Car insurance in the US is complex and requires a great deal of research and oversight on the company’s part. Even with an allowance program, it is important that businesses educate themselves on the particularities of auto insurance to guarantee minimal liability exposure.

Myths

1. Auto allowances "attract talent"

Additionally, there is a prevalent myth that car allowances attract talent.

The reasoning is that they can help to attract top talent because they significantly increase the figure of a salary. If the stipend has a value of $600, it might be adding 10% to an already reasonable salary.

It is difficult to attract and retain skilled travelling salespeople and territory managers. Offering them a car allowance is a way to increase their earnings while requiring them to supply and drive their own vehicle for work.

Because the payment need not technically be spent on automobile expenses, it may impart a sense of freedom to employees. The company needs them to use their personal auto for business, but if they would rather spend their $600 elsewhere, they are at liberty to do so.

In reality, savvy drivers will know that they actually lose money with car allowances because of the heavy tax burden and the lack of correspondence with real driving costs.

Cons

1. Allowances are taxed—twice!

There are, however, serious drawbacks to an allowance program. Foremost among them is the tax burden that the system places on both employers and employees.

Car allowances, because they are paid together with salaries, are assessed for FICA payroll tax and income tax. Depending on a driver’s salary, between 10% and 37% of the car allowance could be paid in taxes.²

If a driver has a salary of $60,000, and a stipend of $600, they will pay approximately $135 in taxes, meaning that they only take home $465 of the car allowance. While the former sum might cover that driver’s fixed and variable car expenses, the latter may well not.

2. Not grounded in real data

Secondly, car allowances are not granular or data-driven. Owning and operating a vehicle involves many fixed and variable costs. A car allowance, paid as a lump sum, has no direct correlation with these costs. It may cover depreciation, wear and tear, fuel, and insurance, or it may not. Without knowing the specifics of a driver’s vehicle make and model, their region, their driving habits, local fuel costs, and more, any round figure is bound to be inaccurate.

It is theoretically possible to estimate the fixed and variable costs of business driving, and set the allowance figure accordingly. However, without evolving real-time data, and without accounting for regional disparities, the allowance quickly becomes obsolete.

In this way, flat rate programs are also inequitable. Drivers who cover territories that cause more wear and tear, require higher insurance premiums, or have higher fuel costs, are left to pay out of pocket when allowances are inadequate.

On the surface, it seems that paying everyone in the company the same figure would engender equality, in reality it under- and overpays different drivers.

3. Driving for work is disincentivized

Because allowances do not correspond directly to the real costs of business driving, they often underpay drivers. Even if the pre-tax figure seems ample, the value after tax deductions may be insufficient.

A driver may also decide to spend their allowance on something other than vehicle expenses. While this was their choice, they may nevertheless find themselves financially strained by unexpected car costs before month’s end.

This disincentivizes driving. If a driver is concerned that their allowance, for whatever reason, will not cover their actual vehicle expenses for the month, they might not drive as often or as far as they should.

This could mean less facetime with clients, fewer personal interactions, fewer prototype demonstrations. Essentially, an exhausted car allowance entails poorer customer service.

The FAVR alternative.

The best alternative to car allowances is a fixed and variable rate (FAVR) program.

How does a FAVR plan address the faults of car allowances?

1. When compliant, FAVR programs are tax-free

A FAVR program can be non-taxable because it accurately differentiates business and personal travel. The IRS wants to allow employee drivers to expense business travel.

As long as the business travel is justified with expense reports (Cardata facilitates this with their app), and the drivers on the program meet the requisite compliance measures, FAVR programs are tax-free. This is one of the reasons FAVR programs cost less than allowance programs.

2. FAVR systems are data-driven

FAVR plans, in order to be compliant, are by nature data-driven. Not only do they separate the fixed and variable expenses of owning and operating a car, but they also account for regional cost disparities.

Using databases and a mileage capture app, Cardata determines reimbursements for a range of expenses including:

• depreciation
• insurance
• fuel
• repairs
• wear and tear

and more. Depending on your region and your mileage band, your reimbursement will be higher or lower. However, the fixed and variable rate program will always cover the exact and actual costs of driving—unlike auto allowances.

3. They do not disincentivize driving

FAVR programs are “behaviour-neutral.” They fairly and accurately reimburse employees for business mileage. There are never gaps between the mileage reimbursements and the actual costs of the vehicles.

Other alternatives to car allowances

Two other alternatives exist to car allowance programs.

One is cents per mile (CPM), which is an IRS standard rate payment for miles driven. This is sometimes referred to as a flat-rate reimbursement, because it only changes when the IRS updates its recommended figures once per tax year. The standard mileage rate for 2021 in the US is 56¢.

The other is a fleet of vehicles that stays at the company workplace. This type of vehicle program might be necessary for certain industries. Pharmaceutical suppliers, for instance, might need a fleet of specialized refrigerated trucks.

If the fleet is left on the lot at night, liability is lessened—while not, however, completely eliminated. Operating a fleet is extremely expensive and difficult.

If all your drivers cover more than 25,000 miles annually, or if you have specialized operations, then it is time to think about fleet.

There are advantages to both fleet and CPM, but neither affords the savings and risk reductions of FAVR systems. Cardata has transitioned tens of thousands of drivers from car allowances to FAVR programs. If your company is on an allowance system, schedule a call with us to learn exactly how much your company could save by switching.

[1] https://www.thehortongroup.com/resources/how-a-small-perk-can-cause-big-problems

[2] https://www.nerdwallet.com/article/taxes/federal-income-tax-brackets

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