If your company requires employees to use their personal vehicles for work purposes, you will need to create an effective car allowance policy that fairly reimburses them, is IRS-compliant, and can save your enterprise money in the long run.
Car allowances can get complicated. From tracking work-related travel expenses to abiding by extensive IRS guidelines, there are a lot of moving parts to account for. However, having a robust and universal car allowance policy in place can help simplify and streamline the reimbursement process by having everyone in your company on the same page.
Before drafting your own car allowance policy, you will need to make several decisions, such as whether your reimbursements will be taxable or tax-free and who is eligible to receive a car allowance. Let’s explore what makes a car allowance policy effective in 2023.
What is a car allowance policy?
A car allowance policy establishes company guidelines for funds reimbursed to employees who use their personal vehicles for work purposes. It outlines employer and employee responsibilities when distributing and spending allowances and how to align them with IRS legislation.
There are a lot of factors involved when an employee uses their personal vehicle on company time, like fuel costs, insurance, and vehicle depreciation. Whether or not you decide to track these expenses for tax purposes, they are important to keep an eye on as they influence how much your company is spending to get your workers on the road.
More often than not, employers end up losing money in two ways. Either their car allowances are being taxed because they are not justified with mileage logs or other reporting tools. Or, they aren’t measuring how far their employees drive or what they usually spend with each allowance.
That’s why the type of car allowance you settle on for your policy matters. Car allowances can either be taxable or tax-free:
- A taxable allowance is a monthly flat-rate payment that does not require mileage logs or data records to justify expenses. As a result, they are included in an employee’s gross income and subject to taxes.
- Tax-free allowances are usually paid in fixed and variable amounts and are not tax deductible—for the most part. The IRS deems car allowances tax-free so long as you provide a detailed mileage log to prove that those funds were solely used for work reasons.
For more information on the differences between taxable and tax-free car allowances, please refer to The Ultimate Guide to Car Allowance for 2023.
As you can see, there are a lot of nuances to be wary of that can impact your company’s finances and overall ability to dispatch drivers. A sound car allowance policy is the way to go to optimize your budget while protecting your employees’ wages and their trust in your company.
What are the benefits of having a car allowance policy?
A car allowance policy is important for organizations because it helps give structure and visibility over the reimbursement process. Employees want to know how much they’ll get paid and the amount of any taxable car allowance. Likewise, employers will want to keep track of how much employees typically spend on the road to better manage their budgets and save money.
With a tax-free allowance, companies can save around 30% depending on their tax bracket. These savings even apply to situations where allowances are not verified, as long as you have other types of evidence to substantiate your use of reimbursement funds. For example, if you forgot to track work miles traveled, providing written or oral verification from business partners visited is often enough to keep your company aligned with tax-free allowance requirements.
Car allowance policies also foster accountability. Both employers and their mobile teams need to be able to rely on each other to accurately draft expense reports and perform other financial obligations. Providing clear instructions on what to track and what allowances should be used helps prevent tax issues and over-budgeting.
By aligning internal processes with IRS guidelines, policies can help ensure that for tax-free allowances, actual mileage rates do not surpass the IRS mileage rate of 65.5 cents per mile. Or, if they do surpass the IRS rate, that tax is only deducted from the difference between the cents per mile value of the car allowance and the IRS rate.
For example, let’s say that you give a mobile employee $700 for the month, and they drive a total of 1,000 miles for work. If you divide their allowance by the number of miles they drove, that turns out to cost $0.70 per mile. Since the IRS rate is $0.655 per mile, you subtract that from your employee’s mileage rate to get a taxable amount of $0.045 per mile.
(Note that, if you have a FAVR car allowance, you do not need to subtract tax from the delta. FAVR is a special allowance program!)
Outlining this process allows employees to understand how allowances and taxes are calculated so they can better monitor how much of their car allowance they are spending and should be spending. Ideally, if the allowance is properly set up, there should be no difference between the expenses and the reimbursement.
What should a comprehensive car allowance policy cover?
Now, for the hard part: figuring out what to include in your car allowance policy. This step can get overwhelming as you try to think of all the components that matter to you and your drivers. Since you will need to abide by IRS guidelines to account for any vehicle reimbursement fund, you can start by focusing on mandatory action items, like:
Allowance amount and type
Will your company offer tax-free or taxable reimbursements? If you choose to issue tax-free car allowances, will payments be structured as a Cents per Mile (“CPM”) or Fixed and Variable Fixed Rate (“FAVR”) reimbursement? Check out our articles on CPM and FAVR to learn more about the pros and cons of each program.
Allowance maximum and breakdown
Think about the maximum limits for each category of expenses you want drivers to stick to, and consider asking for receipts to track expenses above a certain dollar amount. For instance, how much do you expect employees to spend on gas? How about oil changes or new tires? Breaking down costs this way can help drivers monitor allowance use and note changing prices.
Mileage allowance rate
As mentioned, the 2023 IRS mileage rate is 65.5 cents per mile. You can decide if your company wants to max its mileage rate at 65.5 or lower it. If it’s your first time creating a car allowance policy, it may be best to start at the mileage rate and adjust accordingly once you get a better idea of how much your employees drive for work.
Next, it’s time to incorporate company-specific caveats. This is your chance to reflect on what would make internal operations run more smoothly and what you would like employees and leadership to understand about your car allowance program. At a minimum, it is best to include guidance on the following areas:
Not everyone in your company will need to travel for work-related purposes, so it is best to establish eligibility requirements to ensure that you are not wasting car allowance funds on employees who don’t really need them.
Designing a roadmap for submitting expense reports, reimbursement forms, and receipts ensures that all necessary steps are taken care of. In a well-written policy, all parties should know the frequency of reimbursement (weekly, bi-weekly, or monthly), their specific roles and responsibilities, how allowances will be paid (e.g., lump sum, payroll deduction, etc.), and how reimbursements factor into paychecks.
Items that qualify for reimbursement
This includes fuel, tolls, parking fees, car maintenance, insurance costs, items that undergo wear-and-tear, and other expenses needed for your mobile operations. Be explicit as possible here! You don’t want to risk getting taxed for items you forgot to tell your employees about.
The appearance of your vehicle fleet, even when the vehicles are provided by your employees, has an effect on how your business is perceived. You can include direction in your car allowance policy about what employees need to do to make sure their vehicles are up to brand standards. This could include things like asking employees to maintain their vehicles in good working order and keeping them clean.
Remember that you can always update your policy as needed if employees bring up additional costs that were not originally mentioned, you switch car allowance methods, or other related factors change. It doesn’t have to be a perfect first draft, but it should be meticulous enough not to leave major questions unanswered.
Successfully implementing your car allowance policy
Once you have your car allowance policy drafted, you can put it into practice. However, manually managing reimbursements can be time-consuming for both you and your team of employees. You can make this part of the job easier by adopting an automated expense management software system to streamline the process and reduce administrative burden.
The beauty of an automated system is that it reminds employees of how much they’re receiving as reimbursement, how far they are driving, and what expenses they are incurring. With the right software, employees can easily input their travel costs and track their mileage, reducing the risk of human error and ensuring that all expenses are accurately recorded. Employers can also enjoy granular insight into allowance usage, which helps them identify trends and make informed decisions about how to allocate resources.
As I said above, you should review and update your policy as needed to reflect shifting company needs and IRS guidelines. If team sizes and average travel distances change, or if you decide to switch a portion of your drivers to company fleets, your policy has to accommodate this. Additionally, as new technologies emerge and regulations change, you must stay up-to-date with the latest developments in order to ensure that your policy remains compliant and effective. These factors can all significantly impact your car allowance policy, so it’s essential to be flexible, adaptable, and vigilant.
A car allowance policy keeps your company compliant with IRS regulations while ensuring you and your employees use vehicle reimbursement funds wisely. Depending on the nature of your business’ mobile work, tracking expenses can quickly become challenging. But with open communication and the right automation tools, you won’t have to worry about overspending or getting hit with surprise taxes.
If you need a reliable way to implement your car allowance policy, try Cardata. Our reimbursement programs are tailored to support your enterprise needs, with intelligence features designed to automate mileage tracking, so you can save money and get the job done. Book a demo today to test-drive our solutions and experience the Cardata difference.