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Understanding IRS Tax Rules for Car Allowance: FAVR, Accountable, and Taxable Allowance
The Internal Revenue Service offers business owners a fair amount of discretion in how they reimburse employees’ transportation costs. When employees drive their personal vehicles for work, the IRS allows these expenses to be reimbursed tax-free. While in most states it isn’t necessary to reimburse employees, since employees can claim tax deductions for their expenses, nevertheless it is a common and appreciated business practice to reimburse employees when they supply and drive their own vehicles.
As mentioned, there are several kinds of car allowances and reimbursement programs that are either taxed or tax-free. But while each method is equal under the gaze of the IRS, they might not be equal in your ledger. We’ll break down each set of IRS rules for calculating car allowance, and lay out the pros and cons of each.
What are the different kinds of car allowances the IRS recognizes?
The majority of employer-led car allowance programs fall into one of three categories: FAVR, accountable plans under Publication 463, and taxable (or unjustified) car allowance payments.
We cover the three car allowance payments that people encounter most often:
- Fixed and Variable Rate (FAVR) plans
- Plans covered under 463 Accountable Allowance (Tax-Free Car Allowance) rules
- Taxable car allowances
Fixed and Variable Rate (FAVR)
FAVR (or “Fixed and Variable Rate”) plans provide their benefits to employees and employers tax-free.
Cardata prefers FAVR reimbursement programs for a majority of our clients. Here’s why:
- Exempt from tax when proper records are kept—something ‘baked into’ our app design
- Limited insurance liability for employers, and more flexibility for drivers
- Reimbursements based on actual expenses, rather than a flat rate
Employees treat their personal vehicle as their company car, letting them express their personal preferences. They avoid additional commuting to pick up or return company cars. And their reimbursements through FAVR aren’t counted as personal income, resulting in a net deduction to take-home pay.
Benefits to employers are even better. Insurance rates are paid at employees’ individual rates, with an added business use endorsement, and providers won’t spy deep pockets[1] and seek maximum damages in the hopes of winning a corporate settlement.
Why don’t all businesses adopt FAVR reimbursements, given the benefits? Well, it’s complicated.
As in it’s literally complicated. FAVR has multiple compliance measures and must be calculated regionally. An employee living in Hawaii will pay a different price for a new vehicle than an employee in Michigan, and FAVR programs account for this.
To learn more about FAVR compliance measures, you can read this blog next: FAVR Taxes Explained: A guide for program admins | Cardata
What sets FAVR plans apart
FAVR-type reimbursements combine fixed rates—based on employee location for car insurance, state and local taxes, as well as depreciation—and a variable Cents per Mile formula on top based on actual miles driven.[1]
This creates a ‘floor’ for reimbursement. If you have two employees located in the same area, they will both receive the same fixed rate amount, but if Employee A drives twice as many miles in the year as Employee B, the extra miles driven are reflected in their payment.
This second portion is the ‘variable’ amount. It’s also calculated according to a Cents per Mile rate, but lower than the ones in Publication 463. FAVR plans are designed to be responsive to local economic conditions to deliver the most accurate and fair compensation to workers.
It’s cheaper than paying a much-higher flat rate for both, and having excess car allowance taxed away.
It also eliminates edge cases: your employees who put in more mileage and would be punished under a flat Cents per Mile rate typically have those costs covered due to the basic locality calculations.
If this sounds complex, that’s because it is. That’s why our software logs expense and mileage data in real-time, so that everyone on your team is paid fairly and accurately, without admins experiencing any burnout.
What you need to know about Publication 463
The Internal Revenue Service Publication 463 covers rules related to accounting and claiming gifts, travel expenses, and vehicles used for business.
This 35-page tome [2] provides exhaustive information on the many expenses that may not be claimed for business use.
The good news is that a plan under this schedule lets employees have their car allowance payments be tax-free, as long as expenses and record keeping are in compliance with the schedule.
Ultimately, Publication 463 offers two choices: calculation by the standard mileage rate, which changes once or twice per year[3], or tracking actual car expenses, which takes time, energy, and patience—or software!
Standard mileage rate on 463
For 2023, drivers are able to claim 65.5 cents per mile for every mile driven, so long as those miles claimed are strictly “business use”.
The only benefit to this method is that it is easy to use. There is one rule to apply to all cases.
Your employees do not deduct maintenance costs, the price they pay for gasoline, or any other aspect of their vehicle upkeep and maintenance. They pay out of pocket for these expenses, and are reimbursed for a flat rate based on mileage instead.
If the mileage rate you pay on a 463 plan is above the IRS standard rate in a given year, then you only deduct tax from the delta.
Mileage must be tracked precisely, with exact coordinates logged from departure to destination. We’ve got more on that below.
Deducting actual car expenses on 463
Deducting actual dollars spent is also an option.
A quick look through depreciation schedules in Publication 463 tells you that, while this method in theory produces the most accurate results, it does so because it requires employees and employers to track and verify many different expenses each year.
An actual expenses method is similar to FAVR. However, once you have tallied actual car expenses, you don’t have the same compliance measures of FAVR. The only rule with 463 is you compare your total allowance to what you would have received at the IRS rate, and deduct tax only from the delta.
Interested in a 463 Accountable Plan? Cardata’s is called our Tax-Free Car Allowance. You can take a look here: Tax-Free Car Allowance (“TFCA”)
Taxable allowances
In many ways taxable allowances are the easiest to understand: your employer pays you a fixed amount as an add-on to your salary, and the IRS taxes the entire amount as income.
Here’s why Cardata really doesn’t recommend taxable allowances for your business:
- Contributes to perceived salary inflation
- Employees may feel frustrated with dealing with the IRS personally for business use
- Wasteful: ignores the many options the IRS offers for more accurate taxation and compensation
There is one benefit to a taxable car allowance: no requirement to keep detailed records.
But is it worth the cost of additional tax loss? At Cardata, we think absolutely not. Just by implementing a few compliance measures—which you can do easily with a vehicle reimbursement partner, or more laboriously in-house—you can easily save 30% on your total car allowance, and recapture those savings on the employer side, or put it back in your employees’ pockets.
Here are some more articles on why car allowance is not the right choice:
- How payroll and income tax affect business driving
- Why a car allowance is never a good option for business driving
- A quick guide to taxable car allowances
What do I need to track in my car mileage log?
Precise records must be kept for business use of personal vehicles. That means written down in a dedicated file or folder (or diary, if that’s more your style).
All business expense logs must prove the trip was for a business purpose, and log the date, time, mileage, start point and end destination, including odometer numbers.
Cardata offers free resources on how to efficiently log your car expenses each month, including a free-to-use mileage tracking spreadsheet. But our software tracks location data and mileage, locations, and expenses, all in one easy-to-use package, if you’d prefer to go that route.
Tracking car expenses guide for managers
Hello micromanagement: the IRS requires mileage logs to be collected at least quarterly. If you manage a team of five or more drivers, you’re responsible for tracking down your team’s expense reports, plus dozens of hours in lost productivity spent completing the logs.
Cardata offers drivers and managers intelligent solutions that put all the information in one easy-to-access place. It combines precise location tracking, smart route suggestions, and real-time local data. You and your employees save time. And time is money.
Justifying mileage expenses
The IRS is clear: adequate records must be kept for all excursions to be claimed, whether on a FAVR program or otherwise, and deductions cannot be applied to personal use of vehicles, including commuting.
Driving from your home to work can’t be claimed as a business expense, even if you took a client call or stopped to grab gas and fired off an email.
Our location-synced logging puts data at your fingertips, letting you consolidate the reports of multiple employees all traveling to the same conference or warehouse, without the spreadsheets.
Computing allowances
Cardata excels at designing smart car allowance programs for our clients. Our software and mobile apps track miles, expenses, and locations in real-time, storing them in the Cardata Cloud.
In the Cloud, you’ll approve your team’s mileage, seamlessly gather reports (no more badgering emails on the 30th of the month), and find all the records you and your team need in one place.
Conclusion
Whether you have fifty employees or five thousand, it pays to pay attention to the nitty-gritty. Refer back to this guide when reviewing your FAVR car allowance, accountable program under Publication 463, or when reconsidering whether taxable car allowances continue to make sense for your organization’s needs.
The more you understand the IRS’ tax rules for car allowance, the more your business saves.
Cardata has navigated the IRS car allowance rules since 1999, saving clients and employees money with FAVR reimbursement plans. Benefit from our wealth of experience, and schedule a consultation today.
If you are looking for more articles on IRS tax rules, you can check out these two articles next:
Disclaimer: This article, while informative, is not intended to be legal, insurance, or financial advice. For more information on Publication 463 and FAVR allowances, please defer to the relevant literature provided by the Internal Revenue Service or consult a tax professional.
[1] https://www.irs.gov/pub/irs-drop/rp-00-48.pdf
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