Comparing Tax-Free Reimbursements and Taxed Car Allowances

Find the differences between tax-free mileage reimbursement and taxed lump sum car allowances — benefits, drawbacks, and more.

Introduction

As more companies adopt flexible work arrangements and employees use their vehicles for work-related purposes, understanding the tax implications of vehicle reimbursement is essential. When drivers use a personal car for work, their business travel expenses can be compensated through a taxed lump sum car allowance or a tax-free mileage reimbursement program. 

Read on to learn more about the differences between using a personal vehicle for work and having a company car and the advantages, disadvantages, and tax implications of different reimbursement methods.

Personal vehicles vs. Company cars

Whether it’s salespeople traveling for meetings, field technicians doing site visits, or one of the many other jobs requiring business travel by car, companies typically have a plan for supporting business travel expenses. Generally, employees either drive their cars for work trips or drive a designated company car.

When employees use their personal vehicles for business travel, they can drive a car that fits their preferences. Employees are also usually responsible for maintenance, repairs, insurance, and other expenses. In turn, the company often pays them the business expenses incurred  — through a program like a car allowance or vehicle reimbursement. 

Another option is providing employees with a company car. With this, the company owns or leases vehicles for employees to use for work purposes. Employees also aren’t responsible for car expenses, but they typically have to pay personal use chargebacks if they use the company car for personal purposes. On the employer side, there are downsides to company cars, like maintaining company cars and difficulty with scaling. In some cases it’s needed though, when you consider specialty vs. nonspecialty vehicles.

What is a lump sum car allowance?

Car allowances are a common way for employers to compensate employee drivers. Car allowances are usually provided in a monthly lump sum. This can often appear to be the convenient option — a set amount means there isn’t much guesswork in terms of budgeting and organization. However, for many companies, they can also have some big downsides. 

Importantly, these lump sum car allowances are typically considered taxable income by the IRS. When no accounting is done to prove that these are business expenses, the entire car allowance amount is taxed.

Additionally, since they’re at a fixed rate, employees might find that they don’t always cover the cost of their business travel expenses each month — leading them to potentially pay out-of-pocket. On the other hand, if an employee’s car allowance runs out before the month is up, they could postpone business travel to avoid paying for it themselves, which could impact both morale and business success. 

With other businesses out there that have easy-to-use tax-free vehicle reimbursement programs, having a taxable payment could impact hiring and retention, too.

What are tax-free mileage reimbursement programs?

Even though car allowances might seem like the simplest option, they can come with a lot of drawbacks. The good news? There are other options available.

One solution is a Tax-Free Car Allowance. These are different from your standard car allowances because key details are tracked according to IRS guidelines to prove that the payment goes towards business expenses, allowing for the possibility of tax savings both for employees and the employer. 

Another option is a Fixed and Variable Rate (FAVR) reimbursement program. FAVR programs are sanctioned by the IRS as vehicle reimbursement programs. Compared to a vehicle allowance — which is a fixed lump sum payment — FAVR payments are reimbursements related to actual business expenses. Following IRS guidelines allows for FAVR reimbursements to be entirely tax-free.

In Cents per Mile (CPM) reimbursements, employees are given a variable amount that’s based on how many business miles they drove for work. For this reimbursement to be considered non-taxable, the reimbursement needs to be at or lower than the IRS standard mileage rate.

It’s key to be aware that each program has their own rules and regulations from the IRS, and it’s important to be aware of eligibility requirements, compliance rules, and more.

Justifying expenses: The key to tax-free reimbursement

The core of any tax-free solution is keeping detailed records that justify the validity of business travel expenses. For business expenses to be considered tax-free, they need to be tracked to prove that the travel was business related. These need to accurately record key details like trip start and end locations, length, mileage, and more, according to IRS guidelines. 

Substantiated mileage reimbursements allow employees to demonstrate to the IRS that their business travel expenses are accurate and valid. 

This contrasts with standard car allowances, where no details need to be tracked, but where the entire payment is subject to tax. 

How do you make an allowance Tax-Free?

As mentioned before, an accountable allowance program is different from a simple car allowance because of the recordkeeping involved that justifies the business trips taken. These records need to include detailed mileage logs that keep track of information like the business purpose of the travel, and other details that the IRS deems necessary. 

While there’s extra effort here both on part of employee drivers and administrators, it can seriously pay off in terms of tax savings, employee satisfaction, and more.

Advantages of tax-free mileage reimbursement programs

A tax-free mileage reimbursement program carries significant benefits. Beyond the tax savings, employees are also given compensation that’s dependent on how many business miles they drove. With a fixed monthly car allowance, employees might not be compensated fairly for a particularly heavy month of business travel. 

Tax-free mileage programs also benefit employers, too. Employers could avoid paying payroll tax on reimbursements, adding another financial benefit. Also, since reimbursement programs are typically a better representation of actual business mileage driven and business expenses, employers are able to have a clearer picture of work expenses and employee business travel.

A strong vehicle reimbursement program is also a key way to enhance employee satisfaction — which could help contribute to employee retention and productivity. 

Challenges of taxable car allowances

Lump sum car allowances can present some significant challenges, as simplistic as they appear. Importantly, they can be an increased tax burden for employees. When their car allowance is taxed by the IRS as income, it can make the car allowance amount significantly less appealing. 

For employers, a clunky car allowance program can lead to administrative complexities and added work. These negatives could result in employee drivers being dissatisfied with the car allowance program, which could impact turnover. 

How do you implement a tax-free mileage reimbursement program?

Switching from a car allowance program to a tax-free mileage reimbursement program can be well worth the time and effort. Once you’ve decided which program you want to go with, the next step is to put together a clear policy that outlines company expectations, compliance, guidelines for reimbursement, and more.

It’s also best practice to invest time in properly training employees on the processes of your new mileage reimbursement program. Make sure there are ample resources available that provide detailed instructions on recordkeeping and what’s needed for IRS compliance.

Technology can be an excellent way to make implementing and maintaining your program simpler and smoother. Using mileage reimbursement software that follows IRS guidelines can give you peace of mind that the program is compliant. 

Mileage tracking apps — especially when they’re GPS-powered — can also make tracking more convenient for drivers. Mileage reimbursement software can provide a host of other benefits, such as streamlining payments, improved organization and reporting, and more.

Case study: Saving with FAVR

Curious to envision a real-life example of how an effective vehicle reimbursement program can help? Cardata supported an industrial parts distributor in saving 25% on overall costs through a Cardata FAVR program. 

The company had been formerly using a combination of a few reimbursement solutions — mileage reimbursements, car allowances, and company-leased vehicles. A Cardata FAVR reimbursement plan allowed the company to streamline vehicle reimbursement, automate mileage tracking, and give employees the flexibility to drive a car of their choice.

Read through the whole case study to discover more on how this company benefited from a switch to FAVR. 

While each business has its own set of needs and goals, it’s worthwhile to think through the potential benefits of a switch to a more effective vehicle reimbursement program.

Conclusion

For companies where employees need to drive for work, either those drivers will have to use their own personal cars or use a company car. For employees who use their personal cars, it’s common for them to be compensated — and there are plenty of options for employers to do so. 

Whichever option you choose, it’s important to understand the tax implications that your chosen program has both on your drivers and on the company itself. With tax-free vehicle reimbursement options available, consider these options as a beneficial and compliant alternative to taxable lump sum allowances.

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.