How To Calculate A Wear And Tear Allowance For Your Vehicle

Introduction

It is said that your car has lost 30% of its value the moment it drives off the dealership lot. That’s an exaggeration, but vehicles are one of the large purchases businesses make that don’t appreciate over time. That’s one of the reasons why switching to a car allowance program saves business owners so much money: they no longer have thousands of dollars in capital eaten up by depreciation costs.

However, even though your employees are driving their personal vehicles for business use, those vehicles break down just like any other. In this article, we’ll explore what wear and tear does to the value of a vehicle, if depreciation increases with the number of miles driven, and whether businesses can prepare for expected depreciation costs by setting aside a fixed portion of a car allowance payment.

Understanding Wear And Tear

“Wear and tear” is an idiomatic expression that describes how machinery of any sort will degrade over time. While it almost certainly originated to describe vehicles – after all, tires can wear down or be torn – it is now used in various contexts.

Wear and tear is also a legal term often used in warranties. In this context, “wear and tear” means “a form of depreciation which is assumed to occur even when an item is used competently and with care and proper maintenance.” [1] A business will include a fixed portion of the payment to cover depreciation. This depreciation cost isn’t unique to your vehicle. Still, it is calculated in the same way that actuarial tables are based on the general or average case derived from large data sets. 

Let’s take a deeper look at the wear and tear the average vehicle might sustain over a year and how that can affect the amount of a car allowance payment.

Factors Influencing Wear And Tear 

Machines could degrade all at once or slowly over time. A laptop may malfunction because someone spilled a glass of water on it, or its logic board may need to be replaced after ten thousand sleep-wake cycles.

Maintenance costs for vehicles cover both these acute ‘accidents’ and the wear and tear that accumulates over long periods by the forces of friction, gravity, and heat. That’s why your car insurance premiums can sometimes be higher if you’re driving an ancient vehicle.

The number of miles driven plays a significant role in determining how much the vehicle has depreciated. This is why the quality of a used car is typically evaluated by the number of miles on its odometer: high mileage increases the likelihood of mechanical degradation.

Consider your car’s brake pads. The job of a brake pad is to clamp down onto a tire that is rotating very quickly and generating heat. Through friction alone, every time the brake is deployed, a small portion of the brake pad erodes. After a few thousand repetitions of that action, the brake pad will have degraded enough that it can’t quickly stop the car’s wheels to be considered safe. Problems with braking are hazardous and are responsible for many calls to AAA.

Resources For Calculating Depreciation

The Internal Revenue Service does allow businesses to claim depreciation and maintenance costs tax-free as part of specific car allowance reimbursement programs. We have a deep dive into depreciation factors like the retention cycle here, where we present some of the IRS’s primary sources on what can be considered for depreciation costs. You can also use online calculators to estimate depreciation. [2] Car insurance companies often provide these free tools. If you input the make and model of the vehicle, you’ll receive a calculation of the total depreciation from the year it was purchased.

The Annual Impact Of Maintenance Costs

According to AAA, the average maintenance cost for a vehicle is $792 per year or $66 per month. If you add the depreciation cost to that figure, it totals $4551 per year. [3] Fortunately, if you use a car allowance program like FAVR, these maintenance costs will be factored into the amount your business and team can claim tax-free from the IRS. [4] The IRS provides specific schedules for depreciation in Publication 2000-48 (for FAVR) and those claiming actual costs in Publication 463. [5] Verifying your business’s claims against these schedules is essential to ensure you don’t pay a penalty to the Internal Revenue Service.

Tax Implications

What are the tax implications of offering employees money for wear and tear? Here are a few rules to remember when designing a car allowance program that claims maintenance costs. Firstly, if any car allowance payment exceeds the IRS standard mileage rate (read more here), it will likely be taxed as income for every cent above the IRS rate. So, you’ll want to consider that figure as a ceiling price.

Secondly, if you claim maintenance costs, be sure you’ve checked all the IRS regulations concerning the forms you claim. For more information on IRS procedures, you can review our blog here.

The other factor of importance is keeping good records. The IRS requires employees to keep adequate and timely records, and it’s your responsibility as an employer to verify all accounts (within reason). [5]

This should include all receipts for procedures like oil changes, brake pad replacement, any car insurance premiums paid, or any other associated maintenance cost. This is in addition to the mileage logs that drivers must keep.

Maintenance on FAVR programs

On FAVR programs, maintenance is included in the variable portion of reimbursements, because maintenance costs vary depending on the number of miles you drive. More mileage, more maintenance. FAVR can also factor in local repair costs in rate design.

Conclusion: Ask The Experts

The depreciation schedules that the IRS includes in Publications 463 and 2000-48 are both rather complex. It has bands that classify vehicles by mileage driven and programs that incorporate the year model of the car.

If you’re still uncertain about what was discussed in this article, don’t be alarmed; if understanding tax procedures were simple, accountants would be out of business. Accordingly, hiring a specialty firm to manage your vehicle reimbursement program can be a money-saving proposition in the long term. If you need additional help calculating how much to include for wear and tear in your car allowance program, call Cardata. We’ve helped businesses and drivers navigate the highway to FAVR for decades, and our results speak for themselves.

Sources

[1] Wear And Tear | Wikipedia 

[2] Car Depreciation Calculator | Nationwide 

[3] What Does It Cost To Own And Operate A Car | Aaa Automotive 

[4] Rev. Proc. 2000-48 | Internal Revenue Service 

[5] About Publication 463, Travel, Gift, And Car Expenses | Internal Revenue Service
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 nor 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.