AAG: Fixed and Variable Rate (FAVR) car allowances represent the gold standard in terms of accurately and fairly reimbursing employees for their business driving expenses, all while being one of the most cost-effective programs available. Here’s why this tax-free program is our top recommendation for employee-owned fleets.
In this guide, we will explore everything you need to know about FAVR car allowance, including:
- What a FAVR car allowance is
- IRS guidelines for correctly using FAVR
- How FAVR payments work
- How to calculate a FAVR car allowance
- Key differences between FAVR and other types of car allowances
- How FAVR car allowances are administered
and more. Let’s jump right in.
What is a FAVR car allowance?
A Fixed and Variable Rate (FAVR) car allowance is a tax-free mileage reimbursement program for companies with employee-owned vehicle fleets. As its name suggests, a FAVR car allowance is a combination of fixed-rate payments and variable rate reimbursements, giving enterprises flexibility in the way they distribute travel funds.
For example, a company may choose to give their drivers $200 to start the month with and set the variable rate at $0.35 per mile. Employers can adjust the variable rate to best fit market conditions. This enables them to save up to 30% compared to other car allowance options like flat rate car allowances and mileage reimbursements.
The greatest benefit of FAVR car allowances is that they are 100% tax-free as long as employers and employees comply with IRS guidelines and account for all business-related expenses. And unlike other car allowances, FAVR lets companies reimburse their drivers at figures greater than the IRS standard mileage rate of 65.5 cents per mile. This is because FAVR requires that you calculate the actual costs of transportation based on market research, rather than resort to the IRS rate as an average benchmark.
While this program can be tricky to set up and requires an outsourced provider to implement and maintain, it’s worth the investment and is the reimbursement method we recommend the most.
FAVR car allowances guidelines
To qualify for a FAVR car allowance, businesses must follow rules established by IRS 2000-48.
As an employer, the IRS states that you must have at least five employed drivers who use their personal vehicles for work at all times throughout the calendar year. They also must drive more than 5,000 miles a year.
The company’s standard vehicle must also cost less than $60,800 (as of 2023). A standard vehicle is the type of automobile a business chooses to base mileage and maintenance costs off of. Your drivers don’t have to have the exact make and model of the standard vehicle, but the cost of their vehicles must be worth at least 90% of the standard vehicle’s cost. That means if the standard vehicle is a 2023 Toyota Corolla worth $22,000, drivers have to have a car worth at least $19,800 to closely reflect estimated costs.
When calculating the insurance cost in a FAVR allowance, rates should be based on those charged in the base locality for standard automobile coverage. The IRS states that factors such as poor driving records or young drivers should not be taken into account when determining these rates (we’ll talk more about how to calculate these costs later).
Now onto what records you need for program enrolment. To get started with tax-free FAVR reimbursements, your drivers must provide the following information within 30 days of enrolling in their FAVR allowance program:
- The vehicle’s make, model, and year
- A document proving the insurance coverage limits on the vehicle
- The present odometer reading The purchase price of the vehicle or its retail price
- Any maintenance or depreciation costs, such as tire replacements, fuel, and oil changes
Once drivers are enrolled in the program, while they are out driving they have to keep records too. That’s how FAVR programs are justified: with detailed records! To see all the information you need to justify a FAVR program, check out this article:
Cardata | Mileage Log Spreadsheet for IRS-Compliant Mileage Tracking
This is a lot of information to keep in mind, but prioritizing documentation can help your business ensure that it can justify all its expenses.
How do you reimburse drivers for fixed and variable expenses?
As mentioned above, FAVR car allowances include a fixed component and a variable component.
Let’s say that you give your employees their allowance on a monthly basis. At the start of the month, you give them $350 for consistent expenses like insurance premiums, any license and registration fees, and lease payments—this is the fixed rate aspect of FAVR.
Then, after a month of driving, you find out that your drivers traveled a total 600 miles and reimburse them at $0.25 per mile, which equates to $150—the variable rate portion. This helps cover fluctuating costs like those for gas, oil changes, repairs, and maintenance work. That means each month, you’ll be giving your employees a total of $500 for their FAVR car allowance.
Now these numbers will greatly vary for your enterprise depending on where your employees drive, how many miles they accrue, your company’s standard vehicle costs, and regionally-specific factors.
In the next section, we’ll break down how you can come up with a FAVR car allowance amount that closely reflects your drivers’ actual monthly expenses.
Calculating FAVR car allowances for employees
Calculating expenses for FAVR programs may seem daunting at first, but start by breaking down fixed and variable costs to make expenses easier to account for.
Calculating fixed costs
The IRS says that depreciation or lease payments, insurance premiums, license and registration fees, and personal property taxes have to be accounted for. Begin by knowing how much your standard vehicle depreciates every year. There are several online depreciation calculators you can use to get an accurate estimate, including this one from Kelley Blue Book.
After you understand your standard vehicle’s depreciation schedule, divide that by 12 to get a monthly depreciation cost. Add up all other fixed expenses, divide that by 12, and add it to the monthly depreciation cost to get your total fixed monthly sum.
Calculating variable costs
According to the IRS, variable expenses include fuel prices, oil changes, tires, routine maintenance, and repairs. Here, you will need to be mindful of price fluctuations per zip code, meaning if you have drivers across the country, their variable rate reimbursements will differ.
To calculate variable expenses, you’ll need to add all gas, repair, and maintenance costs per mile. For example, if a driver paid $600 for a set of new tires that are slated to last 75,000 miles, that’s a tire expense of $0.008 per mile. Likewise, a driver that spent $6 on gas per gallon and was able to travel 35 miles per gallon, that means gas cost them around $0.17 per gallon.
This is why mileage tracking comes in handy. Recording everything from the dates of travel and trip destinations to extra expenses like tolls and parking fees will prevent your business from overspending or underspending on reimbursements.
Comparing FAVR with other car allowances
When it comes to reimbursing employees for work-related car expenses, companies have several options, including flat-rate car allowances and mileage reimbursements. While both methods provide a way for employees to be funded for car expenses, FAVR has several advantages over the two.
FAVR vs. flat-rate allowances
Flat-rate allowances are the most common type of reimbursement program because they are the easiest to distribute. Employers simply decide on a set amount, say $500 per month, and to give to their drivers. These funds can be taxed or tax-free depending on whether a burden of proof is provided to justify expenses.
As you can see, this leaves little wiggle room for variable costs. Drivers are expected to stay within the range of their $500 budget, meaning they could potentially be overpaid if they don’t drive much throughout the month or underpaid if they exceed their average mileage.
Here’s where FAVR shines…
- First, FAVR is location-specific. The cost of driving in one region might be different than in another region, and driving through different regions can mean that gas prices, insurance, tax rates, and other fees can fluctuate. FAVR takes these differences into account and can be adjusted based on the specific location of the employee.
- Second, FAVR is based on company standard vehicles. Under FAVR, companies can select standard vehicle profiles so that reimbursements are based on the standard vehicle, not on whatever car the employee owns. This ensures that reimbursements are fair and consistent across all employees.
- Third, FAVR protects drivers regardless of mileage. With flat-rate car allowances, drivers may have to drive extra miles to cover car expenses or drive fewer miles to avoid going over their car allowance. This can be unfair and puts the burden on the employee. With FAVR, employees are reimbursed based on the costs of owning and operating a car, regardless of how much they drive.
FAVR vs. mileage reimbursements
A mileage reimbursement is more of an umbrella term for the ways employers can repay drivers for business-related travel expenses. In fact, FAVR is a type of mileage reimbursement. But there are variations of this program that can cost you money in the long run, like Cents per Mile (CPM) reimbursements.
CPM reimbursements use the IRS standard mileage rate as a guideline to calculate driver allowances. All you have to do is multiply your drivers’ mileage by 65.5 cents. So if you have an employee that travels 1,000 miles for work, their monthly reimbursement would be $625.
The problem is, CPM reimbursements aren’t always fair because the IRS rate is not universal or applicable to all company situations. Some employees’ car expenses are going to cost more than the IRS mileage rate, and some are going to cost less.
FAVR takes into account the specific costs of owning and operating a car, which can save companies thousands of dollars per reimbursement. The IRS rate also underpays certain employees, as slow business can cause smaller reimbursements, meaning employees have to pay more work-related expenses out-of-pocket.
Since FAVR takes into account location-specific costs, standardizes reimbursements based on company standards, and protects drivers regardless of mileage it offers a more nuanced and exact approach to reimbursing employees.
How to administer a FAVR vehicle plan
In many FAVR programs, the reimbursement amount for mobile employees is not based on the actual vehicle they drive but rather on the company’s standard vehicle type. Drivers don’t have to own the vehicle type that you choose—they just need a car that, when new, costs close to what the program standard vehicle is worth. This allows for greater flexibility for employees who may already own a car that fits the criteria, rather than having to purchase a new one.
Once a program standard vehicle is selected, you can then determine the miles per gallon, maintenance costs, and other expenses related to owning that car.
By basing reimbursements on a program standard vehicle rather than the actual car an employee drives, you provide funds that are impartial and consistent across all mobile employees. This approach also allows for greater adaptability and cost savings, as companies can select vehicles that fit the needs of their employees while remaining within the IRS guidelines for FAVR programs.
The business case for switching to a FAVR allowance
Bottom line: implementing a FAVR program is a win-win for both employers and employees. It can save companies a substantial amount of money by accurately calculating expenses and providing equitable reimbursements.
FAVR programs take into account the various costs associated with personal car use while giving employees a dependable fixed sum they can count on each month. This means employees can drive with peace of mind, without worrying about going over their allowance or covering car expenses out of pocket.
While setting up a FAVR program can be complicated, companies can leverage external administrators and third-party solutions like Cardata to help establish and maintain the program. This turnkey reduces administrative burden, allowing you to focus on other important aspects of your business.
Explore FAVR with Cardata
We strongly recommend going with a FAVR car allowance for your work-related travel reimbursements to save money, accurately budget, and fairly compensate your mobile employees.
At Cardata, we help make reimbursement easy. Our FAVR car allowance program harnesses powerful software features for automatic mileage tracking and trip recording to ensure that you remain IRS-compliant. We pair your enterprise with a dedicated account manager for extra support and guidance as you embed your FAVR program into your everyday work routine.
Ready for a demo? Book a meeting with us today.