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, and 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.

Is a flat car allowance the right idea?

Instead of creating tailored Fixed and Variable Rate (FAVR) reimbursement programs, many employers offer a standard rate, or flat “Car Allowance,” to pay for all expenses. Giving all workers $300 a month to cover business travel expenses saves the time of calculating individualized FAVR payments, but this method can cost both employers and employees thousands of dollars each year. Car allowances greatly increase expenses through tax waste, cost inequities, decreased employee efficiency, and more.

Despite this, they remain one of the most popular forms of reimbursement. Don’t make the same mistake that so many other mobile workforce managers have made: avoid flat car allowances like the plague.

A simple mistake

It’s easy to see why employers choose car allowances.

Mobile employees must be reimbursed for all the expenses incurred while traveling for work. These expenses can include a wide array of items including fuel, registration fees, license fees, taxes, insurance premiums, vehicle repairs, vehicle depreciation, and more.

To make matters worse, these costs vary considerably over time (oil prices are predicted to be anywhere between $40 and $70 by the end of 2017) and are dependent on the mobile worker’s location. Take for example that car insurance premiums in Charlotte, North Carolina might cost around $1,285 while premiums on the same car might cost $4,259 in Detroit, Michigan.

Trying to account for these different costs can seem overwhelming, so many companies instead turn to a simpler flat car allowance, thinking that this solution is “good enough.” But the drawbacks of a car allowance more than offset the simplicity.

Adding costs through tax waste

Although car allowances are easily reported to the IRS, they raise a company’s Federal Insurance Contributions Act (FICA) tax liability greatly, far more than other reimbursement methods that can be paid tax-free. Because flat car allowances are not based on actual expenses and employees keep any excess payment amounts, car allowances are subject to both FICA taxes for employers and income taxes for employees.

This means that providing a flat monthly allowance of $300 can cost an organization $322, while employees take home only $225. That’s $97 lost per employee each month in taxes.

Lowering efficiency

Flat car allowances encourage employees to drive less for work in order to take home more money. Paying an employee who drives 500 miles a month the same amount as one who drives 1,500 miles a month overpays the low-mileage employee and underpays the high-mileage employee.

This actively incentivizes mobile workers to drive less, or not drive at all, so they can retain any extra reimbursement amount and avoid additional wear and tear on their personal vehicles. As a result, employers end up paying more for their car allowances by decreasing the amount of time employees spend with clients, which lowers efficiency for those in client-facing roles. And, for companies with employees who continue to drive high mileage and incur additional costs, car allowances introduce the threat of class-action lawsuits, since employees must cover additional mileage expenses out of pocket.

The bottom line

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

Flat car allowances are often used in place of customized FAVR programs, but using this one-size-fits-all reimbursement method is not the most financially sound business decision. In fact, companies who reimburse mileage based on the individual costs of driving for business uncover cost savings from their T&E budget. 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 business travel reimbursement.

Start saving with individualized mileage reimbursement

The Author

Danielle Lackey

As General Counsel, Danielle is responsible for all Motus legal affairs and works with strategic business units to drive initiatives that bolster IRS and legal compliance for Motus clients. Prior to joining Motus, Danielle co-founded and served as CEO of Cadence Counsel, a company that helps law firms and companies thrive in an environment where work, as we know it, is rapidly changing. Before founding Cadence Counsel, Danielle practiced as a litigator at Latham & Watkins, representing major corporations and senior executives in complex civil and criminal matters. She earned her J.D. with Distinction from Stanford Law School and is a graduate of Brown University (Phi Beta Kappa, Magna Cum Laude).

Read more by Danielle Lackey

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