A car allowance is a fairly typical vehicle program. However, it’s far from the best option. It is very easy to administer, which plays a large role in its continued popularity. But the largest reason a company might look for an alternative is that a car allowance is not compensation. What does that mean? And what is a car allowance?
Let’s start off with the basics. A car allowance is a vehicle program where companies provide employees with a stipend for the business use of their personal vehicle. The allowance amount may vary from industry to industry, or the employees’ position with the company. The average car allowance of 2021 was $575, and has hovered around that rate for several years. However, a higher-level executive may receive a stipend of $800 as a hiring bonus. So what’s the issue with car allowances? It comes down to compensation.
Unlike other vehicle programs, car allowances are not directly tied to the business mileage employees put on their personal vehicles. Employers could pick a number out of the sky and use that on a monthly cadence. With that mindset, employers might use a higher car allowance during recruiting efforts. If salaries are capped, HR might offer a higher car allowance amount to retain employees going elsewhere.
Companies offer compensation packages to current and potential employees in retention and motivation efforts. Commission, 401k, travel, PTO, these are the kind of perks employees can expect in such a package. What counts car allowances out?
Car allowances are viewed by the IRS as “additional income” because they are not tied to the miles driven by the employee. It’s like receiving a bonus each month. A company may use it to compensate for a lower salary or the fleet vehicle another competitor may offer, but it doesn’t change the fact that car allowance is not compensation. It only invites tax waste. An average $575 car allowance each month might be seen as a benefit to employees if the tax waste didn’t whittle that amount down to $342. Companies also pay taxes on each car allowance, so the tax waste impacts employees and employers. Unsubstantiated mileage also exposes companies to IRS audit.
Employers can prevent tax waste in their vehicle programs by substantiating mileage. One option is an accountable allowance. With an accountable allowance, employees track their mileage and essential information for IRS compliant trip logs. With substantiated mileage, employees receive as much of the monthly allowance as the IRS mileage rate allows. Anything above that rate is considered additional income, and is taxable.
For example, an employee drives 500 miles in a month. They typically receive an allowance of $575. At the 2022 IRS rate of $0.625, their substantiated amount is $321.50. That makes the remainder of their allowance, $253.50, taxable.
But let’s say an employee drives 1,000 miles each month. They also receive a $70 allowance. At the 2022 IRS rate of $0.625, their substantiated amount is $625. That means the amount they drive is actually over the amount of the car allowance. This is another issue with car allowances.
While low mileage employees may benefit from a car allowance, higher mileage employees or employees in areas where gas prices are significantly higher often don’t receive adequate payments for the driving they do. Even an accountable allowance cannot solve that issue.
Companies using car allowances as compensation aren’t putting their best foot forward with current and potential employees. The best way to ensure employees receive fair and accurate reimbursements is providing payments that match the costs of vehicle ownership in their specific location. There are two types of vehicle ownership costs: fixed and variable. Fixed costs include consistent prices, like registration and insurance. Variable costs include shifting prices like fuel and vehicle maintenance. Accounting for both of these costs sets the FAVR vehicle reimbursement program head and shoulders above other vehicle programs.
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