The Pitfalls of Using Car Allowances For Mileage Reimbursement

Mobile workers incur a wide range of expenses as they drive. From fuel and maintenance costs to insurance premiums and depreciation, they must be repaid accordingly. Tracking, processing and reimbursing accurately for these costs is not always easy though, particularly for companies with many mobile workers. The reality is, companies have several options when it comes to choosing a vehicle program that works best for them.

What are the different vehicle program options?

• Fleet programs typically work well for companies whose employees need specialty equipment to do their jobs, like ladder racks or tool boxes.
• Cents-per-mile programs are great for companies who have occasional mobile workers (i.e. those who drive fewer than 5,000 business miles per year).
• Flat car allowance programs reimburse all mobile workers the same dollar amount, regardless of geographic location and mileage driven. This (mistakenly) creates the idea that all mobile workers are being treated fairly.
• Fixed and Variable Rate (FAVR) reimbursement programs are tax-free and reimburse mobile workers for their individualized fixed and variable costs.

Because of their simplicity and reduced administrative effort, car allowance programs can seem attractive. That’s especially true for small businesses or start-ups looking to get a program in place quickly. But are they the best option for the company and its mobile workers?

Is a car allowance the right idea?

Providing all mobile workers $400 a month to cover business travel expenses may save the time of calculating individualized reimbursements. However, this method can cost both employers and employees thousands of dollars each year.

Why?

We know that reimbursing employees for all expenses incurred while traveling for work is important. Employees driving their personal vehicles for work see a wide array of expenses. Those include fuel, registration fees, license fees, taxes, insurance premiums, vehicle repairs, vehicle depreciation and more. These costs vary considerably over time and are dependent on the mobile worker’s location. Compare car insurance premiums in Charlotte, North Carolina might cost around $1,285. On the other hand, premiums on the same car could cost $4,259 in Detroit, Michigan.

This perceived complexity in accounting for different costs can seem overwhelming. This makes it easier for companies to chose a car allowance, thinking that this solution is “good enough.” But the drawbacks of car allowances more than offset the simplicity. Ultimately, car allowances create tax waste for both the employer and employee and decrease employee efficiency.

Car allowances result in significant tax waste.

Although companies can easily report car allowances to the IRS, they raise a company’s Federal Insurance Contributions Act (FICA) tax liability greatly. Other reimbursement methods can even be paid tax-free. Car allowances aren’t based on actual expenses. Because of this, they’re subject to both FICA taxes for employers and income taxes for employees.

This means that providing a flat monthly allowance of $400 to each employee can cost an organization $430.60, while employees take home only $269.40. That’s $130.60 of tax waste per employee each month.

Car allowances decrease employee efficiency.

Car allowance programs encourage mobile workers to drive less for work in order to take home more money. Paying an employee who drives 500 miles per month the same amount as one who drives 1,500 miles per month overpays the low-mileage worker and underpays the high-mileage worker.

This actively incentivizes mobile workers to drive less, or not drive at all. The less they drive, the more allowance they keep. Additionally, the less they drive, the less wear and tear they put on their personal vehicles. As a result, companies end up paying more in allowances while incentivizing employees to spend less time with customers, ultimately decreasing efficiency and productivity. And, for companies whose employees are considered high-mileage and incur additional costs, car allowances introduce the threat of class-action lawsuits, since employees may be able to claim they’ve been underpaid.

There’s a better way to reimburse mileage.

No two business trips are the same, so why would a company choose to reimburse all travelers the same amount?

Companies that reimburse mileage based on the individual costs of driving for business uncover significant cost savings from their T&E budget. With a Fixed and Variable Rate (FAVR) reimbursement program, companies can reimburse their mobile workers tax-free, based on where and how far they drive for work. A business must build FAVR plans on considerable data in order to be IRS-compliant. But there are technologies available that can automate the process, making it easy to employ. FAVR program expenses are tax-deductible for employers and non-taxable to their employees, eliminating tax waste.

As technology improves to meet the needs of the modern mobile workforce, using a flat car allowance has become an antiquated—and very costly—option for mileage reimbursement.

Request a Demo