Fixed and Variable Rate (FAVR) Reimbursements: A Guide
A FAVR reimbursement is a tax-free car allowance for your mobile workforce. An IRS-compliant program, it lets companies reimburse mobile employees who use their personal vehicle for work.
This is the ultimate guide to FAVR, or “Fixed and Variable Rate” mileage reimbursements, for 2023, and you can expect to learn:
- What FAVR is
- Why companies choose FAVR over taxed allowances and fleet
- How to calculate the expenses of a FAVR program
- What mileage tracking has to do with FAVR
- Whether you should outsource your FAVR mileage reimbursement
and more. So, let’s dive right in.
What is FAVR?
FAVR is a mileage reimbursement program or car allowance; which replaces company-owned fleets and taxable car allowances to reimburse employee-owned fleets, tax-free. FAVR is a sanctioned program by the IRS in the United States. The Internal Revenue Service allows you to pay reimbursements to your employees for business driving tax-free.
FAVR stands for “fixed and variable rate” and it’s a kind of car allowance or mileage reimbursement program that lets employees drive their personal cars for work, tax-free.
What mileage reimbursements or car allowances do—and FAVR is just one type of mileage reimbursement or car allowance—is they reimburse employee-owned fleets. So FAVR essentially reimburses mileage expenses on employee-owned fleets, tax-free.
In order to understand what Fixed and Variable Rate programs reimburse for, you need to understand what employee-owned fleets are.
Fixed and Variable Rate reimbursements vs. company-owned fleets
Employee-owned fleets are an employee-owned alternative to a fleet of vehicles that is owned or leased by a company. So with an employee-owned fleet, you no longer need a company-owned fleet of vehicles.
That means you can do all the same business driving that your company was doing before, just with a program that allows employees to bring their own car to work; to drive their own cars on your behalf; to conduct business in the same way that people used to do with a company car.
Companies often want to jettison their company-owned fleet because:
- Fleets carry a lot of insurance risk, because a company car in a car accident outside work hours is still often the company’s problem.
- Cars sit idle when employees aren’t using them, and it is complicated to reassign company cars when employees leave (administrative burden).
- Fleets have high operating costs, involving routine maintenance and repairs.
So for these reasons it’s smart to have an employee-owned fleet instead. This:
- Imparts less insurance risk to the company: car accidents, off the clock, are the employee’s responsibility.
- Cars neither need to be reassigned to new hires, nor sit idle when not in use.
- Employee-owned fleets share the cost of car expenses with employees who drive the vehicles for personal use.
Fleets and taxes
With a fleet that your company owns or leases, obviously this is considered a deductible business expense, to be offset against profits. You do not pay taxes on the expenses that your vehicle fleet incurs. It would be unreasonable if you had to pay tax on the investments that you make in capital—on the tools that you need to run your business; and a fleet of vehicles is something that many companies need in order to accomplish their missions.
While it is easy to deduct expenses like a fleet and not pay tax on the money spent on it; however, when your employees bring their own vehicle to work, it is more difficult to run a tax-free vehicle program in-house. Companies recognize that they need to get rid of their fleet of company cars, but what should they replace it with, in order for it to be tax-free? The best option is a FAVR reimbursement program, but often people choose a simpler (and taxable) option: car allowances.
An important step in understanding FAVR is understanding how it’s a kind of car allowance, just without the tax.
Fleets, FAVR plans, and taxable car allowances
What often ends up happening is instead of a fleet, a company will have a car allowance that gets taxed. A car allowance that is taxed, i.e. one that you don’t justify (FAVR is one examples of a justified version of a car allowance, with proper mileage logs), is therefore 30 or 40% wasted when it needs not be.
Car allowances can be poorly run and taxed at your payroll tax rate, and your employees’ income tax rate. But FAVR is one way to make those car allowances tax-free. A FAVR plan is a justified car allowance that has reporting and data behind it, so the IRS counts it as a tax-free, deductible expense.
A poorly run car allowance, by contrast, is one that doesn’t have any justification—no mileage logs, etc.—and that is therefore taxed at the relevant payroll and income tax rates. It’s just considered income.
If you want to read our full explanation of car allowances, taxable and tax-free, go here: cardata.co/blog/car-allowance.
Definition of FAVR:
At the end of the day, the definition of FAVR is a mileage reimbursement program or car allowance; which replaces company-owned fleets and taxable car allowances to reimburse employee-owned fleets, tax-free. It reimburses your employees for the business use of their personal vehicle.
FAVR is a sanctioned program by the IRS in the United States. The Internal Revenue Service allows you to pay reimbursements to your employees for business driving tax-free, because obviously the IRS understands what I was describing above: that there is a gap created when you switch off of company-owned fleets and go to employee-owned fleets. The deductibility arrangement needs to be filled by some mechanism which acknowledges that any kind of business driving is a legitimate business expense and shouldn’t be taxed.
FAVR stands for “Fixed and Variable Rate,” as I said, and those separate rates are for the fixed and variable expenses that your employees incur while driving for work.
There are two components to a fixed and variable rate program and that is the fixed reimbursement, and then there is a variable reimbursement. There is one rate that is a cents per mile variable rate, and another that is a flat rate allowance. I will describe each in detail shortly.
Is FAVR complicated?
In truth, this makes the FAVR allowance one of the most complex car allowance or mileage reimbursement programs. There are many 30-page IRS tax documents written about these programs, and familiarity with them only amplifies the savings and fairnesses. It pays to know.
One thing that makes FAVR complicated is these fixed and variable components to it, which can be researched and paid independently, with independent variables.
FAVR is more complex than programs for example, which only have a fixed component or programs that only have a variable component. You can run these programs too, and to understand FAVR, you need to understand these alternatives.
Cents per Mile and Flat Rate Allowance:
Fixed cost-only and variable cost-only mileage reimbursements
Variable rate reimbursements (“Cents per Mile”) defined
The most common kind of variable cost-only mileage reimbursement programs are the Cents per Mile (“CPM”), or standard mileage rate plans.
These programs pay a certain amount per mile driven to your mobile employee. The max you can pay tax-free is the IRS standard mileage rate of 62.5¢ per mile. So if your teammate drove 1000 miles one month, and you paid them at the IRS mileage rate, they would get $625 for the month.
The IRS mileage rate:
The IRS rate is the simple variable mileage reimbursement system that allows you to pay the IRS rate or lower for every mile your driver drives on business.
For example, at the time of writing the IRS rate is 62.5 cents per mile. So say your driver drove 1000 miles one month, they would get $625 for the month, tax-free, and you can call it a day.
As long as you just calculate mileage and record other necessities (like the business purpose of their trips, odometer readings, etc., in a mileage log)—if you just keep these records, and you pay the IRS cents per mile rate or lower, that’d be tax-free.
So, you might ask, why would I not just do that? Why would I bother paying or why would I bother doing market research instead of just paying the 62.5 cents per mile tax rate?
Cents per Mile vs. FAVR (why you shouldn’t only pay a variable rate)
WHY YOU SHOULD SWITCH TO FAVR? IT BOILS DOWN TO THIS.
Why should I do market research into variable and fixed costs to come up with two independent reimbursement rates that substantiate and account for employee’s mileage expenses? That sounds like more work than just paying Cents per Mile.
But the reason is that CPM is just sometimes not fair. It is not particularly fair to your drivers or to your company.
Cents per Mile is unfair to companies
The reason it’s not fair to your company is the IRS has done research ahead of time and determined that this is the average rate for the whole country of America, but as we all know with averages, they by definition do not apply universally.
And so what this means is some people’s car expenses are going to cost more than 62.5 cents per mile, and some (most) are going to cost less. Some people will be paying way less for their car. Some people will be paying way more for their car, so your company could end up reimbursing drivers at a number that is way too high for the actual current expenses.
The classic example of this is a high mileage highway driver in Texas, because in Texas fuel prices are generally lower. The Gulf Coast has significantly cheaper gas than the west coast for example, in California. The roads are warm and well taken care of. There is no salt on the roads in winter. You don’t even need to change into winter tires. There are fewer variable and fixed payments to be made.
So let’s say you have a driver that does 40,000 miles per year on Houston highways back and forth. From the burbs to the ports to the regional towns. 40,000 Miles, but barely any wear and tear on his car. And let’s say he drives a Toyota Prius. A small, efficient hybrid car then costs him very little to maintain. It’s five years old, from 2017.
Here’s a look at the table with all the actual costs, and their mileage x the IRS to get their reimbursement value. It shows you how much they’re getting every year, and how much they’re spending, so you can see the delta.
Now let me tell you what he would get in reimbursements every year. And the answer is:
$25,000. So you’re basically buying your employee a new one of these cars every single year. You’re buying him a new Toyota every single year, which is not what this guy needs.
He just needs to be able to maintain his car—and car ownership is expensive—but a Toyota Prius from 2017 does not cost $25,000 per year to run. Let me tell you what it would cost to run this car for you. It would cost you $8,746 to run a 2017 Toyota Prius for a year at his mileage band. That means your company is giving him $16,254 extra. Triple what your company needs to be paying. That’s astonishing.
Why did you start your program? It probably wasn’t to buy a new car for all of your employees every year. You didn’t do it to buy a new car for your employees every single year, but to give them a fair reimbursement.
And that is exactly what FAVR is: fair. FAVR is fairness in mileage reimbursements. So with fairness comes a greater burden on the employer; they have to do the market research themselves. But doing so could save them, as we’ve seen, as much as $16k per year per driver.
Cents per Mile is unfair to employees
The IRS rate also underpays certain employees. In fact the IRS rate is just as unfair to employees as it is to employers; this is especially the case with certain low-mileage drivers who are nonetheless required to own and operate a vehicle on your behalf—for your business.
These drivers include salespeople and merchandisers. People who need, for example, to use their car to go and visit a client in a neighboring town or merchandisers who need to go to a store—at which trucks have already unloaded—to organize goods in an elegant way. These people need to procure a car to do their job; and especially in the early years of car ownership, just owning one is expensive.
For example, a new car has depreciation, insurance, license and title fees. All these things are static costs. They are fixed, they don’t change based on the number of miles you drive in the car. It could cost $600 in that first year of ownership, including depreciation, etc. And if you only drive a few miles one month, your expenses will not be covered.
Let’s say you drive 100 miles one month. That’s just how it is; you don’t have much work; the company is in a downturn. You’re still on staff but you only drive 100 miles. You’re only getting—in that month in the first year after you bought a new car in order to do your job—; when it costs $600 you are getting 62 and a half dollars for the whole month because you drove only 100 miles. 100 miles at the IRS standard rate only gets you $62.50.
That is a devastating blow. It means you’re out of pocket $537.50. But, if you’re a driver, you already knew that. A single month could be a significant setback in an employee’s entire financial year.
As much as influencer culture trivializes $550, that is a real sum of money that makes a decent difference to an employee’s—to anybody’s—future financial well being. So lest you lose $500 and all of its future interest, ask your employer for a FAVR plan.
Fixed rate reimbursements (car allowance) defined
The most common kind of fixed-only mileage reimbursement program is your standard car allowance of, for example, $600 per month.
These flat rate car allowances could be taxed, or paid tax-free if the number was justified. (And I’ll get into how you justify these numbers below.)
But whether it’s taxed or tax-free, if you just pay your employee $600 per month to cover their driving business expenses, that is a flat rate allowance for mileage reimbursement.
The same burden of proof that you need for variable-rate reimbursements applies here too. You need to make sure that your flat rate allowance matches with what employees are actually spending.
One way to do this is by using the 463 accountable allowance methodology, which we call the Tax-Free Car Allowance program. Under this methodology, you keep mileage logs, and then divide their reimbursement by the number of miles they drove in a month. So if you give them 600 dollars, and they drive 6,000 miles, they get 10¢ per mile. Then, you compare that to the IRS rate, and since it’s lower than 62.5¢ per mile, it isn’t taxed. If they only drove 600 miles, they would be technically getting a dollar per mile, and so they would get taxed, but only on the delta. Only 37.5¢ per mile would be taxed, and the sum they received while still at or under the IRS mileage rate ($375) is tax-free.
So that’s how you would justify a flat rate and make it tax-free. But the most powerful kind of reimbursement is a program that combines fixed and variable rates to reimburse for disparate expenses; and this is FAVR.
Fixed and variable reimbursements combined = FAVR
So FAVR is a combination of those two things. What that means is you are paying your employee a certain flat rate per month, for example $300; and a certain variable rate per mile, for example, 25 cents. So every month your employee gets $300 no matter what. Then, once you have tabulated their mileage that they drove on business in the relevant month, you give them, for example, 25 cents per mile.
(You don’t just guess numbers, by the way. In reality you base these figures on market data.)
So if they drove 1000 miles in a given month they would get $550. $250 in variable rate reimbursements: 1000 miles at 25 cents per mile; and $300 flat rate for the month, the same as they get every month.
So you might be wondering, how do you come up with those numbers? And the answer is, at its most broad: by doing market research. This is another thing that makes FAVR more complicated than your average car allowance program. Unlike just using the IRS rate, this is an “actual costs” method of accounting. You need to figure out what the actual costs of driving for work are to pay a true FAVR reimbursement. And you generally do that by looking at local vehicle expenses in the areas where your employees drive.
Let’s discuss this further in the next section, Calculating FAVR.
Ingredients to calculate FAVR’s Fixed and Variable Rates
These are the fixed and variable costs that go into FAVR calculations. This is information that you have to gather in order to calculate your FAVR program rates, as required by the IRS. It can be broken down into two categories, fixed data and variable data.
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,
- routine maintenance,
(Taken from IRS 2000-48.)
You need to figure out how much these expenses cost and add them together into a car allowance. That involves knowing many data points on vehicle expenses. That is no mean feat, which is why a lot of companies like to outsource their FAVR reimbursement plans. That’s who Cardata’s clients are, and if you’re interested in outsourcing a FAVR plan, call us and we’ll see if FAVR is right for your specific needs.
How to calculate variable costs
So you calculate the variable portion by adding up all the variable expenses per mile. An oil change costs, for example, $40, and you need one every 5000 miles, so it costs four fifths of a cent per mile. If gas costs $4 per gallon, and you get 40 miles per gallon, gas costs 10 cents per mile.
You also need to add up what repairs and maintenance cost per mile. So, if new tires are $400, and your tires are rated to last 50,000 miles, your tires cost four fifths of a penny per mile.
And remember that all of these costs can be local. So if you have drivers on the gulf coast, their gas might cost $3 per gallon, and it might be $5 per gallon in California. Repairs, maintenance, and oil changes all also vary in price based on locale. We discuss ZIP codes below.
How to calculate fixed costs
Fixed costs can be calculated by knowing the depreciation schedule, i.e. how much your vehicle type depreciates per year, and then dividing that by 12 for a monthly calculation. Then you also need to know your insurance per month, etc. Add up all the fixed costs listed above and make sure you know the monthly sums. Then you have your fixed rate reimbursement.
Vehicle types and FAVR vehicle reimbursements
In most FAVR programs, your employee’s reimbursement is not based on the actual car that they drive, but rather on a vehicle type. That is one digital representation of a car that you deem reasonable for the job your employees do with it.
Your company, in order to calculate FAVR, can select a vehicle type for different types of drivers within their company. For example, you might be assigned a Chevrolet Blazer as your vehicle type as a merchandizer. If your company needs to have sales people arrive in high style, you can assign a Cadillac or a Lincoln. As long as the cost is below (as of late 2022) $56,100, you can assign the car, and your employees are reimbursed based on it.
However, your employees don’t actually have to own that car. Mobile employees just have to have a car that, when new, cost 90% of the price of the program standard vehicle; so if your vehicle type costs $50,000, they need to have cars that cost at least $45k.
So once you have a program standard vehicle, then you know the miles per gallon, the MSRP, and all the other expenses related to owning a certain car. And once you have all of those expenses, you are ready to pursue an actual costs accounting method to come up with your FAVR rates.
ZIP codes and FAVR
Note also that on the same page, page 7, of the above, there reads the following:
“a periodic payment at a variable rate based on a state schedule for different locales to cover the costs of driving an automobile in connection with the performance of services as an employee is an allowance paid at a flat rate or stated schedule.”
That means you can calculate everything locally. Remember when I said, FAVR is fairness? It’s true especially because of the geographic component.
Not only do you need all the ingredients stated above, you also get to harvest them from the right region. That means if your driver is in Wyoming, you can calculate their reimbursement based on that locale. If they’re in North Carolina, you can pull fuel data from there, insurance data and everything else, and give your drivers an N.C.-specific reimbursement plan.
Gas prices are the primary influence on the variable rate, because they are the largest variable cost and also fluctuate the most.
The variable expenses are considered correspondent to the amount of business mileage an employee drives.
Conclusion of this section
FAVR demands accuracy of the employer, the employer is responsible for market research.
They have to provide data to defend their rate choices.
Now this data includes the stuff that you would normally keep in a mileage log book. A mileage log book looks like the following:
But you don’t have to do it on paper. Mileage log books are everywhere being replaced with mileage tracking apps.
What mileage tracking has to do with FAVR
Mileage tracking is how you get all the data you need to issue a variable rate reimbursement. Primarily, mileage tracking just counts the miles you drive. However, mileage tracking, which has a history in mileage logbooks, also records all of the following information:
- date of the trip
- destination of the trip
- business purpose of the trip
- starting odometer reading
- ending odometer reading
- miles of the trip
- extra expense type (e.g. tolls)
- amount of the extra expense
See the image of a mileage log book, above.
So you can use that mileage logbook to record your miles. You can save the image above and print out as many sheets as you need. Or, you can get a mileage tracking app. A mileage tracking app is not just a simple mileage counter, it also records all of the information listed above.
There are enterprise mileage trackers and individual mileage trackers. Enterprise mileage trackers are usually issued together with mileage reimbursement programs, and are used by enterprises and SMBs. Individual mileage trackers are usually used by Uber drivers, sole proprietorships, very small businesses, and the like, in order to keep records of their mileage for their taxes. You generally do not have a FAVR plan if you’re using a personal mileage tracker.
Examples of enterprise mileage trackers:
These products are great for businesses with multiple drivers.
Examples of personal mileage trackers:
These products are great for the self-employed and independent contractors.
Should you outsource your FAVR program to a mileage reimbursement plan vendor?
Probably. FAVR is complicated and if you are an SMB or an enterprise, you will probably actually save money by outsourcing. You need dedicated, knowledgeable administrators to run one in-house. And if you make a mistake, you could see tax waste. Save your company some headaches and some money by outsourcing.
If you’re ready to discuss outsourcing your FAVR plan, we’re the right people to talk to. Don’t delay, book a discovery call with Cardata today.
Disclaimer: nothing contained in this blog post is legal or accounting advice. Consult your lawyer or accountant and do not rely on the information contained herein for any business or personal financial or legal decision making.