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, the IRS has to set it to be accurate, right?
The problem with using the IRS rate for mileage reimbursement? The IRS does not recommend it as a 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 IRS calculate the new rate based on the previous year’s average costs of operating a vehicle. This 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 best suited for employees that do not drive often for business. Companies generally consider driving more than 5,000 business miles annually “often.”
Some may argue that using the IRS rate for all employees creates a uniform method of reimbursement. In reality, companies using this rate will over-reimburse some employees and under-reimburse others. Take for example, a Los Angeles, California employee paying $2.85 a gallon for gas. Now compare that 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. 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. So too 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.
The FAVR methodology provides each employee with a tax-free reimbursement aligned with their fixed and variable driving costs. FAVR calculates the fixed costs (i.e. insurance, taxes, depreciation) 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.