Business Vehicle Programs: Why is a Car Allowance Taxable?
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Business Vehicle Programs: Why is a Car Allowance Taxable?

By Ben Reiland March 23, 2022

Categories: Anywhere Workforce Vehicle Reimbursement

Why a Car Allowance is Taxable

Across industries, car allowances have long been a favorite vehicle program. The reasoning is as simple as the program itself: a car allowance is easy to implement and upkeep. Which, for a company with hundreds of driving employees, or just a handful, may seem like the way to go. For all anywhere workers, companies share a lump sum each month to cover the costs of business driving in their personal vehicles.

In this blog, we will dive into what a car allowance is, why a car allowance is taxable and discuss a better alternative to an allowance. 

What is a Car Allowance

A car allowance, also known as flat allowance or a vehicle allowance, is a vehicle program where companies provide employees with a monthly stipend for the business use of their personal vehicle. The allowance amount may vary from industry to industry, or even from the employees’ position within the company. While a car allowance is easy to set up and manage, it’s also not the best vehicle program. 

The Average Car Allowance

The average car allowance of 2021 was $576, and has hovered around that rate for several years. However, a higher-level executive may receive a stipend of $800 as a hiring bonus. Car allowances may seem nice upfront, but when you dive into how a car allowance is viewed by the IRS, you begin to see its downsides. 

How a Car Allowance Works 

Employers pick a number and use that on a monthly cadence. Some companies will provide a higher allowance during recruiting efforts or give different amounts depending on the person’s seniority level within the company. It doesn’t matter how much an employee drives or if the price of gas changes, their vehicle allowance will remain the same. 

The Downsides to Car Allowance 

Auto allowances may be easy to manage and offer predictable costs, but allowances do have their drawbacks. This vehicle program does not meet the IRS requirements for substantiation. When companies don’t meet those requirements, the IRS views car allowances as income. That means both employers and employees pay taxes on the allowance. 

Car Allowances are Taxable 

Because a car allowance isn’t attributed to mileage, it’s taxed as additional income. For example, an employee who receives an allowance of $576 will take home about $350 of that monthly car allowance because of tax. While the employee loses out on receiving the full allowance amount, the employer also pays taxes. The average annual vehicle allowance costs employers about $7,441 per employee in the program when their portion of payroll tax is included. Due to the tax waste an allowance creates, employees only take home $4,729. 

Car Allowances Create Winners and Losers 

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. 

Employees quickly learn that the less they drive, the more their car allowance becomes actual compensation. As a result, car allowances may incentivize employees to drive fewer miles, even though it could mean sacrificing extra sales and revenue. 

What does this mean for your employees? 

Your employees may not be receiving enough. A car allowance is not configured to their typical driving schedule or the region they have to cover. Many drivers may be overpaid, while others will receive an amount too small to make up for their driving expenses. Being taxed, it’s even less likely to cover an anywhere worker’s needs. And, with the passage of the TCJA, they can no longer deduct unreimbursed business mileage from their taxes. Many companies have paid out millions of dollars in lawsuit settlements over under-reimbursed anywhere workers. As more states fall in line with California and Illinois’ Labor Laws, companies want to guarantee their mobile workers the reimbursements they deserve. 

When compared with other vehicle programs, why is a car allowance taxable? 

Companies with car allowance programs aren’t the only ones to face this dilemma. Businesses that use a mileage reimbursement program, also known as a cents-per-mile program, without proper substantiation are also taxed. They also face taxation when they reimburse at rates above the IRS standard mileage rate. 

How to Calculate a Car Allowance for Employees 

Now you know what makes a car allowance taxable, it’s time to start looking for alternatives. A great starting point would be an accountable allowance program. While still a car allowance, an accountable allowance ensures a certain amount of driver’s reimbursements remain untaxed, granted the company submits the proper information. 

By using a mileage tracking app, companies ensure their driving employees capture each business mile accurately. Further, with the right provider, a mileage tracking app will capture all the necessary information to make the mileage log IRS compliant. This automated process means employees spend less time on administration in the field and more time on their jobs.  

However, accountable allowances still fail to reimburse employees accurately for the geographic costs of vehicle ownership. 

Create a Fair and Accurate Vehicle Reimbursement 

If you’re interested in a vehicle program that provides the very best for your employees, look into a fixed and variable rate (FAVR) reimbursement program. FAVR programs ensure employees are paid for both the fixed and variable expenses of vehicle ownership that vary by location. Fixed costs would include license and registration fees or insurance payments, amounts that change infrequently. Variable costs include fuel, tires, maintenance and other factors that are more likely to change. Companies with FAVR programs use mileage reimbursement rates designed to the driver’s region and submitted trips. That means employers pay the right amount and employees receive the right amount. It’s a win win! 

Interested in learning more about FAVR!

Learn about FAVR

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