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Torben Robertson

5 mins

How payroll and income tax affect business driving

Payroll and income tax are both deducted from flat rate car allowances. As much as 30-40% of a car allowance can be lost to taxation.


How do payroll and income tax affect business driving?

Payroll and income tax are deducted from poorly structured business vehicle programs. However, the IRS allows vehicle reimbursement programs to be tax free. Intelligent vehicle reimbursement programs can totally eliminate vehicle program tax burdens.

There are 3 systems for business driving

When your employees drive for work, they need to have that expense covered. There are a variety of ways that you, as a business owner, can do this. The three major systems for business driving are the following:

  1. A fleet of company cars
  2. Non-taxable vehicle reimbursements
  3. Taxable car allowances

1. Fleet

Fleets are the most expensive program, and should only be used when companies need specialized vehicles, like climate controlled food transport trucks.

‍2. Reimbursements

Non-taxable vehicle reimbursements are programs (designed by companies like Cardata) that adequately account for business driving to the IRS, which allows these programs to be tax-free (completely or partially). They allow companies to operate without fleets, because employees supply and drive their own vehicles on these programs.

Examples of these programs include:



C. Tax-Free Car Allowance

3. Car allowance

Taxable car allowances also enable employees to supply and drive their own vehicles for work, but are subject to taxation.

Why would you ever want to pay a car allowance?

Cardata never recommends paying car allowances. Generally, companies pay allowances together with payroll, and they pay a lump sum—like $1000—to their employees to supply and drive their own vehicle for work.

They see these payments as easy ways to cover their employee’s driving expenses. But the tax-waste from these programs, especially with large driver populations, means that the ease of these programs is not worthwhile.

What are FICA and payroll taxes?

Payroll taxes are taxes withheld from paychecks which are not classified as income tax. FICA is one kind of payroll tax.

FICA stands for “Federal Insurance Contributions Act.” It is deducted from every paycheck, and both the employee and employee contribute. The deduction goes toward Social Security and Medicare. The employer and employee each pay 6.2% of the paycheck to Social Security, and 1.45% of it to Medicare, for a total of 15.3% [1].

FICA—sometimes called FICA and MedFICA—is one part of Federal payroll tax.

So, we see that at least 15.3% of every car allowance is lost to tax when it need not be. But there is more.

There is also FUTA—the Federal Unemployment Tax Act—which dictates that 6% be withheld from the first $7,000 paid to employees annually [2].

Then there are state payroll taxes: SUTA, where S stands for State, which ranges from 2-5% (though paying SUTA can reduce your FUTA burden [2]).

Are there other taxes to which car allowances are subject?

Yes! Car allowances are also subject to income tax. Both Federal and State income taxes are deducted.

Income taxes may be either flat or progressive, meaning that they are either consistent across all income brackets, or that the rates go up in relation to rising income brackets.

The state with the highest flat rate income tax is North Carolina, where the rate for everyone is 5.25%. California has the highest progressive tax rate, with top earners paying 13.3% [3].

Then there is Federal Income tax, which ranges from 10%-37% [3].

Lastly, there are Local Taxes, which vary widely from city to city [4].

So, if a driver in North Carolina was making $40,526 per year, and they received a car allowance to drive for work of $1,000, they and their employer together would pay at least $425 per month on that allowance. That does not include FUTA or SUTA tax, or any local taxes.

This is why Cardata recommends a tax-free vehicle reimbursement program. The same value of that allowance can be paid tax-free when companies implement FAVR or Tax-Free Car Allowance Programs.

Why are car allowances subject to these taxes?

A car allowance is considered taxable because there is no “adequate accounting” for the expense [5]. Car allowances are essentially treated as if they were any other form of compensation.

In Publication 5137 Rev. 2-2020, the IRS gives an example of car allowances:

“An employer provides an employee with a car or mileage allowance and does not require substantiation. The accountable plan rules have not been met; the car allowance is fully taxable as wages to the employee” [6].

The IRS allows for driving programs to be established within a company with reduced tax burdens. However, because these programs have high reporting standards, companies often opt to take the easy route and pay allowances.


There are certain cases where vehicle reimbursement programs will see some tax. This occurs when drivers are out of compliance with the IRS regulations relevant to their program.

References and further reading:






[6] page 44

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