As we get ready to flip the calendar to 2022, organizations are preparing themselves for what’s to come in the year ahead. At this time, the Internal Revenue Service (IRS) is also gearing up to release its annual mileage rate for the upcoming year.
While this rate has been used as a standard mileage deduction in years past, employees can no longer deduct business mileage from their taxes. So, what is its business purpose and what factors may contribute to the 2022 IRS mileage rate?
For those who may not be familiar, the IRS standard mileage rate is a benchmark that companies can use to pay tax-free reimbursements to employees who use their own vehicles for business.
Prior to the 2018 Tax Cuts and Jobs Act (TCJA) enacted by the Trump administration, drivers were able to write off business mileage on their taxes. Once signed into law, this act no longer allowed employees to claim mileage as a business expense deduction. Many companies responded by reimbursing their employees who use their personal vehicles for business driving at or below the IRS mileage rate to remain compliant with state and federal labor laws.
Companies still use this rate to reimburse employees who use their personal vehicles for business driving. However, that is not its intended application. The IRS mileage rate is a guideline for mobile worker reimbursement because it is the threshold for taxable reimbursement. Employee reimbursements are tax-free as long as a company’s allowance or cents-per-mile reimbursements are not above the annual rate.
The IRS monitors trends in business driving based on analysis from the world’s largest retained pool of drivers to calculate this rate, which is then used to determine taxation. If a company provides a reimbursement higher than the IRS standard mileage rate, that reimbursement becomes taxable. Below are some of the major factors that impact business driving and how the rate is calculated.
While there are more expenses to driving than just fuel costs, they still play a significant role in calculating the 2022 IRS mileage rate. Fuel can make up as much as 23% of driving costs, and while most of the components of gas prices are typically stable, crude oil prices change daily and are the main influencer of prices at the pump. Market volatility has remained a constant since the start of the pandemic due to below-normal levels of consumption, an oversupplied market and production disruptions such as the Colonial Pipeline ransomware attack and the Texas Freeze.
These extenuating circumstances continue to disrupt conventional price cycles and make it challenging to accelerate production back to pre-pandemic levels. After gas prices finished 17% lower in 2020 than they did in 2019, they have a strong footing heading into the final months of 2021. Increased fuel consumption has aided the market’s push to work through the supply glut of 2020 and the pushed the national average price for regular unleaded fuel to $2.87 – a 24% increase year-over-year.
As vehicle demand diminished at the height of the pandemic and the economy went into a recession, auto manufacturers that remained open scaled back their vehicle production. Not only has consumer demand for vehicles returned, it has actually exceeded post-pandemic expectations and suppliers have been unable to keep pace. The combination of high demand, limited purchasing options and the absence of dealer incentives have driven new and used vehicle prices to record highs. The average used vehicle price is now $20,400 while the new vehicle retail transaction price has eclipsed $40,000 for the first time ever.
One of the biggest constraints on the global automotive supply chain has been the chip component shortage. When vehicle sales began to climb again, chip production wasn’t readily available to source. From computer management of engines to driver-assistance features such as emergency breaking, a single part for the modern, heigh-tech vehicle uses as many as 500 to 1,500 chips depending on its complexity. Given the heavy reliance on these components, the inability to procure proper parts has forced manufacturers to cut global production by up to 40%.
Depreciation typically goes up year over year, and may have had a similar influence on the 2022 IRS mileage rate. This past year, however, has been different. The disparity between supply and demand has created a pricing bubble that is amplifying costs and residual values. This caused depreciation rates to fall. Depreciation rates also fell more rapidly than anticipated due to disruptions in the supply chain and uneven recovery in many sectors. Vehicle depreciation had been holding steady in the 12-17% range year-over-year prior to the pandemic. However, in 2020 alone there was an 88% year-over-year decrease. Vehicle depreciation remains 70% lower than pre-pandemic levels in 2021, and it will take time for these levels to normalize.
While the average cost of vehicle insurance dropped by nearly 4% in 2020, insurance rates are making their way back to pre-pandemic levels because more drivers are returning to the road. Insurance premiums decreased for the first time in nearly a decade as a result of fewer miles driven and reduced claims, but bad driving habits picked up during the pandemic has accident frequency in 2021 trending toward 2019 levels. Premiums are likely to resume the trend of year-over-year increases and impact the 2022 IRS mileage rate.
If your company reimburses at the 2021 IRS mileage rate of 56 cents per mile, we encourage you to seek an alternative program. Why?
Several vehicle program alternatives may be a better fit for your businesses, such as the Fixed and Variable Rate (FAVR) reimbursement. This approach, the only IRS recommended reimbursement methodology, accounts for both the fixed and variable vehicle use costs. Learn more about FAVR here.