Introduction
The Internal Revenue Service handles the many tax withholdings, claims, and deductions it must process via an elaborate system of forms that taxpayers must fill out. If you own a business or help manage one, you may already be familiar with the Form W-2; most employers and employees working in America will file a Form W-2 each year. Readers of Cardata’s previous articles know that car allowances – monetary reimbursement for business use of a personal vehicle – aren’t always tax-free. So you may wonder whether you – or the employees you manage – must report car allowances on a Form W-2 when filing taxes this year.
What is a W-2 Form?
The W-2 form is one of the primary forms that the Internal Revenue Service provides for reporting income. Officially titled “Form W-2, Wage and Tax Statement,” it is filed by an employer on behalf of their employee (who must verify and sign it.) Most businesses in the United States will file at least one Form W-2 per year.
Who needs to file a Form W-2?
On their ‘About’ page for the form, the IRS writes:
“Every employer engaged in a trade or business who pays remuneration, including noncash payments of $600 or more for the year (all amounts if any income, social security, or Medicare tax was withheld) for services performed by an employee must file a Form W-2 for each employee (even if the employee is related to the employer) from whom…Income, Social Security, or Medicare tax was withheld.” [1]
This paragraph clarifies that virtually every business must file a Form W-2 so long as the employee made at least $600 in gross pay from their employer over the year. This includes “noncash payments.” If you ran a butcher shop and had an arrangement with an employee who requested to be paid in frozen meat, you would still need to file a Form W-2 so long as that meat’s “fair market value” exceeded $600. [2]
The comprehensive application of this form might lead us to conclude that all car allowances must be reported on Form W-2 as income. However, while most car allowances do, this is not always the case, for example when a car allowance is really a vehicle reimbursement, which distinction we will examine below.
Let’s examine the different programs you might use to reimburse your employees for business use of their vehicles.
Different car allowances and their tax implications
There are multiple ways to reimburse your employees when they drive their cars for business purposes. As an employer, you can design a car allowance as you see fit. However, most will fall under the following four categories:
- Lump-sum car allowance. Employers provide employees with a lump sum of cash to supplement their wages. The typical lump sum car allowance is disbursed annually or monthly. This kind of car allowance is taxable.
- FAVR vehicle reimbursement program. This is a newer program introduced by the IRS as an alternative to their Cents per Mile (CPM) standard mileage rate. It involves two payments: a fixed payment for stable costs such as depreciation and insurance and a variable payment of a certain number of cents per every mile driven. The cents per mile rate for a FAVR car allowance is lower than the standard mileage rate below due to the addition of the fixed portion of the allowance.
- Cents per Mile reimbursement. Cents per mile reimbursement involves a flat rate of cents multiplied by the miles your employee drove for business use throughout the reporting period. The rate is tax-free up to an including the IRS standard rate.
- Reimbursing actual expenses. This involves reimbursing employees for their exact receipt expenses. However, since employees must save and report every receipt and navigate complex IRS depreciation schedules, it has a far higher administrative burden than other car allowance programs.
Should I report my employee’s car allowance on Form W-2?
Let’s return to the IRS statement on employer obligations for filing W-2 forms above.
Employers “must file a Form W-2 for each employee…from whom Income, Medicare, or Social Security tax was withheld.”
Are car allowance payments withheld for income tax or other taxes above? The answer may surprise you: it’s got everything to do with whether your reimbursement is considered an accountable benefit plan.
Accountable versus non-accountable benefit plans and car allowances
A benefit plan is considered an “accountable” plan if it satisfies the following three criteria laid out by the IRS.
- They must have incurred the expenses in performing their obligations to their employer. In this instance, the payment must reimburse the expenses incurred while using their vehicle for business purposes.
- These expenses have been substantiated to you, the employer, within a reasonable amount of time, usually 30 days.
- Any overpayment or excess reimbursement must be returned to the employer.
The good news is that any car allowance payment that satisfies all three criteria is not considered income or wages, does not have Social Security, Medicare, or income tax withheld, and does not need to be reported on a Form W-2.
An important caveat: Form W-2 Box L
This benefit only needs to have taxes withheld or be reported on Form W-2 if it exceeds the federal standard mileage rate set by the IRS.
Any amount provided for employee reimbursement that exceeds the IRS standard mileage rate must be reported in Box L of Form W-2.
Scenario: You employ Graeme, a salesperson. Graeme received $675 for their car allowance payment last month. They drove 590 miles for work in the same month. Do you need to report Graeme’s reimbursement payment on Form W-2?
Yes. Graeme drove 590 miles for work. 590 multiplied by the current IRS standard mileage rate of 67 cents per mile equals $395.30. The first $395.30 will not be reported on the Form W-2 and will not have tax withheld. The remainder of $279.70 will have taxes withheld from it and will be noted in Box L of Form W-2.
Lump-sum car allowance with no accountability
Drivers and their employers must beware the lump-sum car allowance that has no reporting. If no miles are tracked, no business purpose or destination recording in a log book, then the entire allowance is considered taxable, and must be reported on the W-2. The allowance, with no substantiation, will be taxed at the relevant employee’s personal tax rate, and all state and local taxes must be deducted as well. This means that your employee, and you the business owner, could be losing 30% or more of the allowance to income and payroll taxes.
Read more about whether your car allowance is taxable: Is Your Car Allowance Taxable?
Conclusion: Make Your Car Allowance Payments Count
Reimbursing your employees for business use of their vehicles is a complex subject. When you factor in the additional requirements that a program like FAVR necessitates, it can feel like you’re swimming in the deep end of the pool of tax compliance. Cardata has helped businesses design fair, equitable, and efficient car allowance programs since 1994. Our results for our clients speak for themselves. Contact us to discover how your company can save on car allowance payments, or follow us on LinkedIn for more informative posts, videos and articles.
Sources
[1] About Form W-2, Wage and Tax Statement | Internal Revenue Service
[2] About Publication 15-B, Employer’s Tax Guide to Fringe Benefits | Internal Revenue Service
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.
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