When reimbursing a mobile workforce for its business-related vehicle expenses, finding a fair and accurate method that abides by the Internal Revenue Service (IRS) procedures – including, but not limited to, the IRS mileage rate – is essential. Fixed and Variable Rate (FAVR) car allowance programs are a popular approach to reimbursement rates, as they combine simplicity and flexibility. But how exactly does one calculate this type of allowance?
This article offers a step-by-step guide to enumerating car expenses, so you can understand precisely how a FAVR plan works. Whether you’re an employer looking to optimize your reimbursement process or you’re a self-employed small business owner seeking a bit of clarity on how these numbers are crunched, this comprehensive guide will equip you with the knowledge and tools needed to unravel all aspects of IRS-compliant variable and fixed rate vehicle programs.
If you’re new to FAVR, you can start by checking out our complete guide.
Understanding FAVR car allowances
Definition of FAVR allowances
A FAVR allowance is a comprehensive reimbursement plan employed by businesses to reimburse employees for the expenses associated with using their vehicles to accrue business mileage. Unlike Cents Per Mile programs, which exclusively reimburse at a variable mileage rate, and only when the car is moving, FAVR combines fixed and variable rates to create a flexible reimbursement system that covers the often stationary and moving costs incurred during business travel. The fixed component of FAVR accounts for the relatively steady expenses of business driving, like insurance, license fees, and depreciation—the expenses required to put a car in your driveway. At the same time, the variable feature is adjusted based on operating costs, such as fuel prices, maintenance, and the number of miles traveled.
Importance of FAVR allowances
Implementing FAVR offers several advantages for both employers and employees. Firstly, it ensures fair reimbursement based on actual costs of a program standard vehicle. Unlike flat, standard car allowances or bare-bones mileage reimbursement plans, which may not accurately reflect the actual expenses, FAVR programs consider the specific costs associated with each employee’s unique driving habits. Additionally, utilizing FAVR helps companies maintain compliance with tax regulations.
Indeed, the IRS developed the FAVR method as an acceptable way to reimburse employees without incurring additional tax liabilities; by adhering to IRS guidelines, businesses can avoid potential tax waste. With fixed and variable rates calculated based on comprehensive data, employers can establish a standardized process that simplifies mileage expense tracking and reimbursement calculations. This saves time and minimizes the risk of errors and disputes.
Components of a FAVR allowance
The fixed portion of a FAVR allowance is a fundamental element in calculating the total reimbursement for employees using their personal vehicles for business travel. This fixed allowance accounts for costs that remain constant over time and are associated with vehicle ownership and operation. It includes insurance premiums, taxes, license fees, and depreciation.
Insurance premiums play a significant role in safeguarding employees and employers by providing coverage in the event of accidents or damages. On the other hand, license fees are necessary for legal compliance and allow employees to utilize their vehicles for business purposes. Lastly, depreciation accounts for the gradual decrease in a vehicle’s value over time, acknowledging that the wear and tear incurred during business travel impacts the car’s overall worth.
According to the IRS, calculating periodic fixed payments involves two steps:
- First, one must divide the total projected fixed costs of the standard automobile for all years of the retention period, determined at the beginning of the retention period, by the number of periodic fixed payments in the retention period
- Then, one must multiply the resulting amount by the business use percentage.
In contrast to the fixed allowance, the variable payments of a FAVR allowance encompass costs that fluctuate depending on mileage . The variable rate includes, fuel, maintenance, and repairs. By incorporating these variables, businesses can ensure that employees are reimbursed for dynamic business expenses that would otherwise be overlooked.
Mileage is a primary variable factor in the calculation of the variable allowance. By accurately tracking and recording mileage, businesses can establish a reliable foundation for determining the variable portion of the FAVR allowance. Fuel prices also play a significant role in the variable allowance, as they can vary over time and across different regions. Fluctuations in fuel costs directly impact the overall expenses incurred during business travel, and incorporating this factor into the variable reimbursement helps maintain an accurate and up-to-date reimbursement structure.
Routine maintenance (including oil changes), , and general wear and tear are inevitable aspects of vehicle ownership. By considering historical data and scheduled average maintenance, businesses can ensure that the variable allowance reflects the expenses of these vehicle-related services. The IRS notes that variable costs are central to any FAVR reimbursement program and must be “reasonably calculated not to exceed the amount of the expenses or the anticipated expenses.”
Identifying variable factors
When implementing a FAVR allowance, it is necessary to identify and consider critical variables that accurately capture the costs associated with business travel. Mileage rates, gas prices, maintenance, and all the fixed costs in a given region, are all potential variables to incorporate into the calculation. By comprehensively analyzing these factors, businesses can establish a robust reimbursement structure that aligns with employees’ actual vehicle-related expenses.
A step-by-step guide to calculating a FAVR allowance
1. Choose a program standard vehicle
- A program standard vehicle is a digital representation of a car on which your FAVR program will be based. Since all FAVR programs have at least five drivers, FAVR programs are not designed based on individual vehicles, instead select the vehicle which it is reasonable to drive for the job.
- For example, you might assign your drivers a 2022 Ford Escape. The employees have the freedom to drive whatever they like, however they will be reimbursed on the program standard vehicle.2. Choose a business use percent
- This is usually 71.4%, that is, five days of the week of driving for work, divided by the seven days of the week.
- This will determine what percent of the vehicle expenses are the employer’s responsibility.
3. Set the driver’s location and territory
- The location and territory will determine what values to assign to fixed and variable reimbursements. LA drivers will not receive the same variable rate as, for example, Houston drivers, because gas is much more expensive in LA.
4. Set the mileage band
- A mileage band is how far you expect a driver to go per year. The most common mileage band is 10,000 to 15,000 miles per year.
- This impacts depreciation, because the longer you keep a car, the slower it will depreciate.
- It also impacts the maintenance costs of the vehicle, because the more you drive a vehicle, the more maintenance you will need.
5. Calculate fixed costs
Now, to calculate the fixed costs associated with the FAVR allowance, based on the program standard vehicle, and the operating territory. This section will walk you through the steps of identifying and determining the fixed elements of the allowance.
- Identify fixed elements: Fixed costs encompass consistent expenses that do not fluctuate based on mileage or other variable factors. Identifying these elements accurately is essential to ensure fair and accurate employee reimbursement. On a FAVR allowance, these costs should be identified regionally, using local expense data. Some expected fixed costs to consider include the following:
- Insurance premiums
- Registration fees
- Determine annual fixed cost: To calculate the fixed cost, sum up all the identified fixed elements. More specifically, you must add the vehicle’s insurance premiums, registration fees, taxes, and depreciation; the total represents the fixed costs incurred over a year. By accurately determining the annual fixed price, businesses can establish a baseline for the fixed portion of the FAVR allowance. This fixed amount ensures that employees are reimbursed for the consistent expenses associated with vehicle ownership and maintenance.
6. Calculate variable costs
- Determine mileage rate: The mileage rate is an indispensable component of the FAVR allowance calculation. It represents the cost per mile that the employee incurs during business-related travel. It includes:
- Oil changes
- Calculate annual variable cost: Once you have determined the applicable mileage rate, the next step is calculating the variable yearly cost. To do this, multiply the mileage rate by the total business miles traveled during the year. The whole business miles can be obtained from the mileage records collected during the tracking process. By multiplying the mileage rate by the total business miles, you get the annual variable cost, which represents the expenses associated with business travel. These expenses include fuel costs, maintenance and repairs, and other variable costs related to the vehicle’s usage.
7. Combine fixed and variable costs
Now that you have calculated the fixed and variable costs associated with the FAVR allowance, it’s time to combine them and determine the total FAVR allowance. This section will guide you through combining the fixed and variable costs to obtain the final reimbursement amount.
- Add fixed and variable costs: To calculate the FAVR allowance, add the total annual fixed price to the yearly variable cost. This sum represents the total reimbursement amount covering the employee’s vehicle-related expenses incurred during business travel. The annual fixed cost includes insurance premiums, registration fees, taxes, and depreciation. It accounts for the predictable and consistent costs employees experience regardless of usage or mileage. On the other hand, the annual variable cost represents the variable expenses that fluctuate based on factors such as mileage, fuel prices, maintenance, and repairs. These costs are directly linked to the employee’s business travel and the actual usage of the vehicle.
8. Gathering expense data
- Track mileage: Accurate employee mileage tracking is vital to calculating a FAVR allowance. It provides a central metric for determining the variable portion of the reimbursement. There are several methods to record mileage for business-related travel. One option is manually tracking mobile employees’ progress using a spreadsheet-derived mileage log. This involves recording each business trip’s starting and ending mileage and any additional miles driven for work-related purposes. While manual tracking requires diligence and discipline, it can be a cost-effective solution for smaller organizations. Alternatively, mileage tracking apps and devices are available that automate the process. These tools use GPS technology to track and record mileage automatically, eliminating the need for manual input. They provide accurate and convenient mileage data, ensuring employees are reimbursed based on the distances traveled for business purposes.
- Collect supporting documentation: In addition to mileage tracking, it is crucial to collect and retain supporting documentation for fuel, maintenance, repairs, and other relevant expenses. This documentation shows the costs incurred during business travel and provides transparency in the reimbursement process. Retaining receipts and invoices for fuel purchases is a fundamental practice insofar as one must verify the expenses associated with vehicle fueling. These receipts should indicate the date, location, and amount spent on fuel, allowing for accurate reimbursement based on actual costs. In addition, maintaining receipts and invoices for maintenance and repair services is very important to prove the expenses incurred to keep the vehicle in good working condition. These documents help validate the variable costs related to vehicle maintenance and repairs.
9. Issuing the reimbursement
- This must be done at least quarterly.
- It is often done monthly.
10. Use a reimbursement partner instead!
If all that doesn’t sound like the kind of thing your HR team wants to do, just skip steps one through nine, and call us. Cardata will do the hard work for your team, so you can relax and just drive.
Maintaining compliance and adjusting the FAVR allowance
Once you have determined the FAVR allowance, it’s important to ensure ongoing compliance and make necessary adjustments to keep up with changing circumstances. This section focuses on maintaining compliance with tax regulations and periodically reviewing and adjusting the FAVR allowance.
- Compliance considerations: Staying updated with tax regulations is necessary in order to ensure that the FAVR allowance remains within acceptable limits and that the organization complies with reporting requirements. Tax laws and regulations related to vehicle reimbursements can vary, and it’s imperative to stay informed about any changes that may affect the FAVR allowance. By regularly monitoring and understanding tax regulations, businesses can ensure that their reimbursement practices align with the current guidelines and avoid potential penalties or compliance issues. Consulting with tax professionals or seeking expert advice can be beneficial in navigating the complexities of tax compliance concerning vehicle reimbursements.
- Periodic review and adjustment: Besides compliance considerations, reviewing and adjusting the FAVR allowance periodically is key. Costs associated with vehicle ownership, maintenance, and fuel prices can fluctuate over time. Gasoline, in particular, is a contentious issue that requires a keen eye. It is necessary to reassess the reimbursement amount to ensure it accurately reflects the current costs incurred by employees during business travel. Regular reviews of the FAVR allowance enable organizations to stay aligned with market rates and economic changes. This practice ensures that employees are fairly reimbursed for their vehicle-related expenses and that the organization’s reimbursement policies remain competitive and current. During the review process, businesses should consider factors such as changes in mileage rates, fuel prices, maintenance and repair costs, and any other relevant factors that may impact the overall expenses.
Accurately calculating a FAVR reimbursement for business travel necessitates an astute analysis of both fixed and variable costs that your dedicated drivers are required to take on. By adhering to the step-by-step guide outlined in this article, any business can understand FAVR allowances with confidence, guaranteeing equitable reimbursement for their employees while upholding the tenets of tax regulations. By embracing this methodology, enterprises pave the way for enhanced financial stewardship and a workplace culture that values the well-being and satisfaction of its employees and avoids underpayment. Ultimately, an employee reimbursement structure of this nature can empower organizations to thrive and adapt, setting the stage for long-term growth and success.
Disclaimer: Nothing in this blog post is legal, accounting, or insurance advice. Consult your lawyer, accountant, or insurance agent, and do not rely on the information contained herein for any business or personal financial or legal decision-making. While we strive to be as reliable as possible, we are neither lawyers nor accountants or agents. For several citations of IRS publications on which we base our blog content ideas, please always consult this article: https://www.cardata.co/blog/irs-rules-for-mileage-reimbursements. For Cardata’s terms of service, go here: https://www.cardata.co/terms.