When it comes to mileage reimbursement, there are a few options that employers can choose. Options include: car allowances, the IRS mileage rate, cents-per-mile rates (other than the IRS), and fixed and variable rate (FAVR) programs. The option that many companies choose is the IRS rate because it seems the most standard and the easiest. I mean, if it’s set by the IRS, it has to be accurate, right?
The problem with using the IRS rate for mileage reimbursement is that the IRS rate is not a recommended reimbursement rate. Its main purpose is to serve as a base rate for individuals to calculate a tax deduction for their unreimbursed driving expenses, a tax deduction that is no longer available.
Each year, the new rate is calculated based on the previous year’s average costs of operating a vehicle; which means the rate is inherently inaccurate – it’s not reflective of current prices, and it’s based on nationwide averages, rather than location-specific costs. As a result, the IRS mileage rate is really best suited for employees that do not drive often for business (less than 5,000 business miles annually) or are not reimbursed by their employers and are looking for a simple way to write-off business expenses on their taxes.
Drawbacks of the IRS Rate for Mileage Reimbursement
Some may argue that using the IRS rate for all employees creates a uniform method of reimbursement, but in reality, some employees will be over-reimbursed and some will be under-reimbursed. Take for example, a Los Angeles, California employee paying $2.85 a gallon for gas compared to a Hanover, New Hampshire employee paying $2.05 a gallon. The California employee receives the same reimbursement per mile but is spending $0.80 more per gallon, and differences in other driving costs could further heighten this discrepancy.
The costs of gas, insurance, maintenance, license fees, and other general vehicle expenses vary widely across the country, and so should mileage reimbursement rates. Only the fixed and variable rate (FAVR) methodology – which is the IRS’s only recommended reimbursement approach – ensures this is the case.
A More Accurate Solution
The FAVR methodology provides each employee with a tax-free reimbursement that’s aligned with their fixed and variable driving costs. The fixed costs (i.e. insurance, taxes, depreciation) are calculated for each individual based on where they live. The variable costs (i.e. gas, maintenance, tires) are based on distance traveled and current gas prices in an employee’s driving territory.
Reimbursing employees based on their location and mileage-specific costs makes the FAVR methodology the fairest and most accurate reimbursement option a company can choose. It may seem more difficult to adopt than simply using the IRS rate for all employees, but the benefits of providing both tax-free AND accurate reimbursements make FAVR programs a far superior mileage reimbursement method for most companies. By paying the right amount, companies can eliminate over and under-reimbursements – providing cost savings and mitigating legal risk – and, they can ensure all employees are treated fairly.