What is a Retention Cycle in Vehicle Reimbursements?

Introduction

When it comes to effectively managing employee vehicle reimbursements, depreciation costs, and retention cycles hold pivotal, yet distinct, roles in determining fair and accurate remunerations. Indeed, diving into the complexities of retention cycles and their influence on vehicle reimbursement programs is the only way to guarantee satisfied drivers. In this article, we will explore the significance of depreciation, retention cycles, their relationship with reimbursement rates, the impact of reimbursement software, and the potential tax implications of being outside the depreciation cycle.

Defining our terms

Depreciation

Depreciation is the gradual decline in value that occurs as a vehicle ages and experiences wear and tear. It is influenced by several factors, including the initial cost of the vehicle, its age, mileage, condition, market demand, and technological advancements. The Internal Revenue Service (IRS) provides very particular guidelines on how businesses can recover the cost of vehicles over time through depreciation. These guidelines, such as the Modified Accelerated Cost Recovery System (MACRS), offer a structured approach to determining depreciation expenses.[1] MACRS provides specific recovery periods and depreciation methods based on the vehicle’s class, which is determined by its intended use. For example, passenger cars are generally depreciated over a period of five years using the 200% declining balance method. 

However, it’s important to keep in mind that certain limitations and restrictions apply. The IRS places caps on depreciation deductions for luxury vehicles to prevent excessive tax benefits. For passenger cars, the maximum depreciation deduction in the first year is limited to a certain amount, and subsequent deductions are subject to annual depreciation limits. To ensure compliance with IRS guidelines and make informed decisions, businesses should maintain accurate records of vehicle costs, including the purchase price, date of acquisition, and any improvements or modifications made. These records are crucial for calculating depreciation deductions and substantiating claims during tax filing.

By understanding vehicle depreciation and following IRS guidelines, businesses can effectively manage their tax liabilities while accounting for the inevitable decline in value that occurs as vehicles are utilized over time. It’s advisable to consult with a tax professional for personalized advice and to stay up-to-date with any changes in IRS regulations related to vehicle depreciation.

^{[1] Modified Accelerated Cost Recovery System (MACRS) Definition}

Retention cycles

A retention cycle is the method by which depreciation is factored into vehicle reimbursements. A retention cycle refers to the predetermined period during which an employee intends to keep a vehicle before replacing it. In other words, it is the length of time an employee is scheduled to drive a specific car for business purposes in the context of a reimbursement program. The cycle starts the year in which the vehicle was released, e.g., if an employee purchased a 2023 model the moment it is released (usually in the previous year, in this case, 2022), extra time may be added to the retention cycle.[2]

^{[2] IRS Rev. Proc. 2009-54}

The relationship between retention cycles and reimbursement rates

Retention cycles are typically 3-7 years in duration. The retention cycle is selected by the employer, and then the employee’s vehicle (the program standard vehicle) has it’s depreciated value calculated during that period. Retention cycle depreciation is normally calculated using straight-line depreciation.

Straight line depreciation

=

(the cost of an asset – estimated salvage value)

–––––––––––––––––––––––––––––––––––

the estimated useful life of an asset

Here, the value at the end of the retention period is subtracted from the value at the time of car purchase; the remainder is the amount of depreciation; that value is then divided evenly over the number of months in a retention cycle and added to the fixed reimbursement to cover the cost of depreciation. This is why a longer retention cycle will inevitably result in lower fixed reimbursements. To better illustrate how this works, let’s unpack two specific scenarios:

• Scenario 1: a 3-year retention cycle with a total depreciation[3] of $7,500 would result in a fixed monthly reimbursement of $208.33 to cover vehicle depreciation over the 36-month, or 3-year, period.
• Scenario 2: a 5-year retention cycle with a total depreciation of $10,000 would lead to a fixed monthly reimbursement of $166.67 for the 60-month, or 5-year, duration.

Cardata specializes in the construction of retention cycles into FAVR programs based on the needs of employers and their employees.

^{[3] Total “business use” depreciation. See Business Use Percentage Guide: FAVR vs. Fleet | Cardata.}

The importance of a structured retention cycle

Implementing a structured retention cycle within reimbursement programs ensures consistency and fairness in reimbursement calculations. It allows employers to accurately forecast and allocate funds for employee vehicle reimbursements. By aligning the retention cycle with industry norms and the specific needs of employees (usually according to driver habits and goals), organizations can optimize their expense management processes and provide equitable reimbursement amounts.

The impact of reimbursement software

Reimbursement software, such as the kinds offered by Cardata, facilitates the integration of retention cycles into FAVR programs. This software streamlines reimbursement calculations by automating the process, providing accurate and efficient results. It offers the flexibility to tailor retention cycles based on the customer’s requirements and the unique circumstances of their employees, ensuring compliance and transparency.

The implications of being outside the depreciation cycle

Don’t panic – if an employee is outside the depreciation cycle, it does not necessarily mean they must immediately purchase a new vehicle. Instead, they can continue receiving their FAVR reimbursement; however, there may be tax implications. For instance, they might be subject to taxation on the portion intended for depreciation. This is why vehicles with a significant amount of pre-existing depreciation usually do not qualify for FAVR programs but are still reimbursable under the structure of other reimbursement methods. Despite potential taxation, opting for a FAVR reimbursement – when possible – still offers numerous benefits. If tax compliance is a primary concern, you can read more about its relation to FAVR here: FAVR Taxes Explained: A guide for program admins | Cardata. 

Conclusion

Retaining a comprehensive understanding of retention cycles is crucial for employers and employees alike when it comes to vehicle depreciation and reimbursement programs. By comprehending the relationship between retention cycles and reimbursement rates, leveraging reimbursement software, and acknowledging the implications of being outside the depreciation cycle, organizations can effectively manage employee vehicle reimbursements. By embracing structured retention cycles, businesses can ensure precise reimbursement calculations, maintain compliance, and foster a transparent and satisfactory work environment for their dedicated mobile employees.

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 or 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.