Employees driving for business purposes require reimbursements for their mileage. In many states, not reimbursing employees for business mileage is a violation of labor laws. But companies can also reimburse employees an amount that is taxable. So, timely to tax season, we wanted to answer some of the common questions we receive: Is mileage reimbursement taxable? What makes a tax on mileage applicable? And, how can companies avoid a tax on mileage reimbursement? For those of you working on the taxes for the previous year, we’re going to share the answers – read on for more.
Tax on mileage isn’t applicable to all driving employees. In fact, there are two specific business vehicle programs that face tax on mileage. One is a car allowance, or vehicle allowance. The other is mileage reimbursement. Let’s dive into why.
A car allowance works exactly how it sounds. Employers reimburse employees each month at a flat rate. This model is largely popular, as it’s easy to implement and maintain, as the rate only changes annually. These models are taxable because they are non-substantiated payments that are not determined based on variables, but are set based on an agreed upon sum. So, if the vehicle allowance reimbursement rate technically exceeds the IRS rate—set at 65 cents per mile for 2023—it’s taxable.
Mileage reimbursement or cents-per-mile (CPM) compensates employees for a set rate for every mile driven. These programs are a popular option for companies that have a small, regional mobile workforce, as well as national companies that have a handful of mobile workers who don’t spend a whole lot of time on the road, Similar to a car allowance, if the CPM reimbursements exceed the 65 cents per mile IRS rate, these reimbursements are taxable.
To provide tax-free reimbursements for employees, companies can switch to an accountable allowance or begin reimbursing employees at or below the IRS mileage rate. However, before doing this, it’s worth evaluating the other potential downsides of car allowance and cents-per-mile reimbursement programs.
Aside from tax considerations, these programs do not account for the fixed (i.e., insurance, licensing, registration) or variable (i.e., maintenance, repairs, fuel) costs that employees may be incurring as a result of driving their personal vehicles for work. This creates “winners and losers,” or employees who are being reimbursed substantially more as compared to others who might be paying more out of pocket. This not only hurts employee morale if individuals feel they are being under compensated, but opens up the potential for costly lawsuits in states where companies are legally required to compensate their employees for each and every expense they incur throughout the course of doing business.
For employers looking to provide fair, accurate and compliant reimbursement for employees, it’s worth considering a Fixed and Variable Rate (FAVR) reimbursement program. These models are tax-free and account for all fixed and variable costs of vehicle ownership and an individual’s use of that vehicle for work purposes.