The true cost of a car allowance

Introduction

There are a lot of employee benefits that will entice an employee to a role including car allowances, which often seem like a convenient and attractive perk. However, that isn’t always the case, because the true cost of a car allowance can reveal some significant hidden expenses and inefficiencies. In this blog, we’ll uncover why traditional in-house car allowances aren’t all they’re cracked up to be, as well as how modern alternatives can provide far more cost-effective and equitable solutions.

What are car allowances?

A car allowance is an employment benefit where employers provide a stipend or flat rate sum to employees for the use of their personal vehicles for business purposes. These allowances are typically intended to offset expenses like gas prices, car insurance, and wear-and-tear or depreciation. While an in-house managed employee car allowance may seem simple and straightforward, the actual costs associated with operating one of these vehicle programs often outweigh the perceived benefits.

Spotting outdated and inefficient car allowances

Unnecessary tax waste

One of the biggest drawbacks of in-house car allowance programs is the significant amount of the benefit that is wasted on unnecessary tax. Most car allowances are considered taxable income by the IRS because they do not follow the IRS’s standard rate. This means that employees end up paying around 20% in federal income tax, approximately 2% in state tax (varies by state, with states like California often having higher rates), and 7.65% for FICA contributions. [1] [2]

For example, an employee receiving a $500 monthly car allowance would only take home about $350 after all of the various taxes. Employers also have costs, as they are responsible for their portion of FICA contributions. Overall, this results in a total tax waste of approximately 37%, significantly reducing the perceived benefit of the car allowance. [3]

Disconnected from employee needs and driving expenses

Traditional car allowances often fall short of addressing the real-world needs of employees. These allowances are usually not geographically specific, meaning they don’t consider the varying costs of driving in different states, for example. 

This approach can lead to unfair and inefficient spending. For example, employees who drive high-mileage for business purposes may find their allowance insufficient at covering their actual vehicle costs, while those low-mileage drivers might receive more than they need, pocketing the difference. The lack of mileage reimbursement programs that adjust based on miles driven and actual costs results in an inefficient reimbursement system.

Risk of non-compliance 

Handling tax-free car allowances (TFCA) in-house can pose significant IRS tax compliance risks. Without proper mileage logs and documentation (which is much more common than one might expect) companies are at risk of audits and penalties from the IRS. Inadequate tracking and non-audit proof practices can lead to annoying and expensive fines, as well as damage to the company’s reputation.

Alternatives to traditional car allowances

To address these issues, companies should consider modern alternatives to traditional car allowances. Solutions like Cardata’s vehicle reimbursement programs (VRPs) which offer more accurate and fair compensation to employees on the road for their business mileage. Some of these programs are more geographically sensitive, use cost data, and are IRS tax compliant.

Vehicle Reimbursement Programs (VRPs)

These programs reimburse employees based on the actual number of miles driven for business purposes. By using the IRS standard mileage rate as the benchmark, businesses can ensure fair, accurate, and tax-free reimbursement for their mobile employees.

Fixed and Variable Rate (FAVR) Programs

A FAVR program, like the one offered by Cardata, combines a fixed payment for fixed costs, including car insurance, depreciation, taxes, and license and registration fees, with a variable payment based on variable elements like gas, maintenance, and tires. This method ensures that employees are equitably reimbursed for their business use without over or underpayment.

Benefits of modern alternatives

Reduced tax waste 

By following IRS guidelines and using tax-free vehicle reimbursements, companies can significantly reduce tax waste.

Fair and efficient spending

Use-based reimbursement allows for payments that align with actual vehicle usage costs, leading to more equitable compensation – and happier employees.

Compliance

Proper documentation and audit-proof processes minimize the risk of IRS audits and penalties.

Conclusion

There are a lot of hidden costs and inefficiencies with traditional car allowances, which can easily outweigh the benefits. By understanding the true cost of a car allowance and exploring more viable alternatives, companies can provide more equitable, efficient, and IRS tax compliant solutions for their employees. It’s time to move away from outdated practices and adopt modern vehicle reimbursement programs that actually meet the needs of today’s workforce on the road.

Sources

[1] https://www.irs.gov/pub/irs-pdf/p463.pdf 

[2] https://taxfoundation.org/data/all/federal/latest-federal-income-tax-data-2024/ 

[3] https://www.ssa.gov/people/materials/pdfs/EN-05-10297.pdf 

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.