How Much Tax Will I Pay on My Car Allowance?

Introduction

Around late March of every year, thousands of workers around all fifty states begin wondering, “How much tax will I have to pay on my car allowance?” No doubt, the uncertainty around income tax payments causes stress for many. When you add complex variables, such as taxable fringe benefits, tension can compound faster than interest after a rate hike.

To lower your stress before next year’s filing, it’s essential to understand the type of car allowance you have, whether it is a tax-free program or a taxable fringe benefit and what implications these conditions have for your annual taxes. This article will help you understand the different types of car allowances available and how they are regulated by the Internal Revenue Service (IRS). We’ll also provide an example to illustrate how other car allowance methods can affect your income tax bracket.

Understanding car allowances

A car allowance is an informal term that describes any monetary supplement over and above your base salary that is expressly provided to reimburse for expenses incurred while driving for business purposes.

Some businesses offer a car allowance as an annual lump sum payment. Others distribute that exact figure monthly. Many provide a fixed dollar amount for every mile logged and driven. The IRS offers more complex forms of car allowance, called “accountable car allowances,” including Fixed and Variable Rate (FAVR) programs, which is the most flexible kind of reimbursement.

Understanding IRS rules for accountable fringe benefit plans

Aside from calculating your business mileage, the first step in calculating the tax you will have to pay on your car allowance is figuring out whether it is accountable or nonaccountable. If a program meets the IRS’s definition of accountable, “allowances or reimbursements paid to employees for job-related expenses are excluded from wages and are not subject to withholding.”[1]

This definition determines how much you will pay in tax on your car allowance this fiscal year. If your employer’s program does meet the accountable plan criteria, you can drive with the confidence that you won’t pay any income tax on the amounts you receive for your car allowance. According to the IRS Publication 5137 [1], otherwise known as the Fringe Benefit Guide, your car allowance is considered an accountable plan if it satisfies the following criteria:

• There is a business connection to the expenditure.

• There is adequate accounting by the recipient within a reasonable period.

• Excess reimbursements or advances are returned within a reasonable period.[2]

Are car allowances considered income?

It depends on the car allowance program. As stated above, if the plan meets the IRS’ requirements, it is considered an accountable plan and not taxed by the IRS.

But not all car allowance programs are the same. If your employer’s car allowance program does not satisfy the above criteria, it is automatically considered a non-accountable plan.[3] Publication 5137 confirms that all car allowance “payments, including advances, reimbursements, allowances and so on, made under a nonaccountable plan are taxable wages subject to all withholding.” 

In theory, this provides a simple way to verify whether or not your car allowance payment was considered taxable income by the IRS. If you refer to your most recent pay stub (or the pay stub that contains your car allowance payment if it is distributed as an annual lump sum), look at what amount was withheld for taxes.

In theory, if you are on an accountable program, the amount you receive for your car allowance should be listed separately from your salary, and it should be clear that Social Security, Medicare, and federal tax were not withheld from this amount.

However, this is a significant caveat: if your employer did not file or withhold your taxes correctly, at the end of the day, it is your responsibility to verify this information with the IRS. The “pay stub method” can be a convenient shortcut, but it assumes that your employer is entirely up-to-date with IRS regulations and procedures, which sadly isn’t always the case. Asking your manager about the details of your car allowance program or asking a licensed tax representative can clarify whether or not your car allowance is considered income.

Deductions and credits for car allowances

The IRS lists many possible conditions for deductions and credits concerning transportation expenses, which can be found in IRS Publication 463. [4] If you are self-employed, additional conditions apply, which can be found here. [5]

The most important takeaway for this year’s tax return is checking your Form W-2. If your car allowance is under an accountable plan, there should be no record in Boxes 1 and 14 of your Form W-2.[6] If it is listed as income under Box 1 or 14 of Form W-2, you are either on a non-accountable plan or your employer has it in error. Either way, talk to your employer to verify the information is correct.

Cardata also strongly urges you to verify this with your licensed tax professional or your employer’s payroll department.

Examples of tax brackets and car allowance tax payments

These figures are speculative, “in a vacuum,” and meant to illustrate how different car allowance programs can affect personal income tax rates. Of course, IRS filings are rarely this simplified, and you will likely have many deductions and benefits to apply. These figures assume zero additional deductions and credits other than gross pay and car allowance payments.

• Q. John makes $91,656 annually. On top of this, they receive a lump sum of $8,000 a year on January 1^st for their car lease payment. How much will John pay in income tax this year?

• A. Since the lump sum method does not meet IRS accountable plan criteria, the car allowance is added to their salary and considered income for $99,656. This places them in the third income tax bracket for single incomes of $95,376 to 181,200. They can thus expect to pay an income tax of 24% on their gross income.

  John will pay a total of $23,917.44 in income tax this year. Of this amount, $1920 was paid out of the car allowance lump sum. That’s almost 10% of their tax burden — an amount that could have been tax-free.

It also bumped them up to a higher tax bracket, so they paid more on their base salary than they would have if on an accountable plan.

How To Maintain Your Tax-Free Status

If you’re wondering how to maintain your car allowance’s tax-free status this year, check out Cardata’s guide to accountable car allowance programs.

Conclusion

Car allowance payments can be – and should be – tax-free. That’s why understanding IRS rules for car allowances is so essential. The only difference between an accountable car allowance program and a non-accountable one is compliance with IRS regulations and procedures. Cardata helps businesses navigate car allowance programs and choose a route that leads to increased savings for businesses and employee job satisfaction. Consult one of our experts today to get started.

Sources

[1] Fringe Benefit Guide – Publication 5137 | Internal Revenue Service

[2] Rev. Rul. 2006-56, Section 62(c) | Internal Revenue Service 

[3] Treas. Reg. Section 1.62-2(c)(3-5) | Internal Revenue Service 

[4] About Publication 463, Travel, Gift, and Car Expenses | Internal Revenue Service 

[5] Topic No. 510, Business Use of Car | Internal Revenue Service 

[6] Form W-2 – Use of Company Car/Vehicle | Tax Act 

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 nor 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.