Mileage Reimbursement: When to use the IRS rate

Let’s set the record straight: no, the IRS mileage rate is not a required mileage reimbursement rate.

Set by the IRS, the standard business mileage rate serves as a “safe harbor” to calculate the tax-deductible costs of operating an automobile for business. The IRS mileage rate is calculated annually and is meant to reflect the “fixed and variable costs of operating an automobile.” However, it is not a prescribed mileage reimbursement rate. It’s a rate at which employees can claim tax deductions for un-reimbursed driving expenses, without needing justification beyond an IRS-compliant mileage log.

Organizations can choose to use flat car allowances, Fixed and Variable Rate (FAVR) reimbursement programs, the IRS rate, or a cents-per-mile rate that differs from the IRS rate when reimbursing employees. With so many options, it’s easy to see why there’s confusion and why companies often just default to using the IRS rate for mileage reimbursement. And while the IRS rate is simple to use and can be paid tax-free, it’s important to know the drawbacks of a cents-per-mile rate and when the IRS mileage rate makes the most sense for mileage reimbursement.

Fairness of a Cents-Per-Mile Reimbursement Program

The downside of reimbursing based on the static IRS mileage rate is that it does not account for daily fluctuations in fuel prices or variances in regional vehicle ownership costs. Instead, the rate is derived from weighting and blending cost factors for a variety of vehicles across the country.

On the surface, the per-mile reimbursement approach for all drivers — regardless of territory type, location, or number of miles driven — may be thought to work best, because treating employees equally is often regarded as one and the same with treating employees equitably; however, when drivers have widely varying travel or expense patterns, they are treated inequitably under a uniform mileage reimbursement structure.

Some vehicle costs, like insurance, fuel, vehicle registration, etc., vary substantially by geographic area and can drive wide differences in vehicle ownership and operating costs for drivers. As a result, using a flat cents-per-mile, like the IRS rate, can under-reimburse employees in higher cost areas and over-reimburse employees in lower cost areas.

When used for frequent travelers, the IRS standard mileage rate also tends to under-reimburse low mileage drivers and over-reimburse high mileage drivers. Consider an employee in Detroit who is required to own and use a car for work but only drives about 5,000 business miles a year. The employee would receive $2,900 using the current IRS rate of 58 cents, which may not even cover his or her insurance premiums (they can top $5,000 in some Detroit zip codes). On the other hand, an employee who drives 25,000 business miles a year would receive $14,500 – over one-third the price to buy a brand new car and a hefty over-reimbursement for the majority of us. As a result, when you have a true mobile workforce, a more dynamic mileage reimbursement, like a fixed and variable rate (FAVR) program, allows employers to more accurately reimburse their employees who drive regularly for business.

Customized, IRS-Compliant FAVR Reimbursement Programs

Like the IRS mileage rate, reimbursements calculated under a FAVR program are eligible for tax-free status. However, under a FAVR program, mileage reimbursements are customized for each employee based on their location and business miles. Employees in high cost areas like Detroit receive a higher fixed reimbursement than those in low cost areas. Additionally, employees’ variable reimbursements account for both current fuel prices and their business mileage. By taking these unique variables into consideration, FAVR reimbursements more accurately reflect the driving costs employees incur.

Although a FAVR program is typically more accurate and cost-effective than the IRS mileage rate, there are some limitations. There are various guidelines for reimbursements to qualify for tax-free status, among which are the following: employees must drive at least 5,000 business miles a year, and at least five employees must be reimbursed using the FAVR methodology at all times during the year. And while employers can still choose to use the FAVR methodology regardless, any reimbursements paid in excess of the IRS mileage rate would automatically be subject to tax.

Choosing the Right Mileage Reimbursement Program

The IRS mileage rate is typically the most effective solution for employees who drive sparingly for business and don’t meet the minimum 5,000-mile threshold to qualify for tax-free reimbursements on a FAVR program. These employees tend to make one-off business trips rather than relying on their cars each day to perform their jobs. The IRS mileage rate also tends to be the best option for companies with less than five employees who regularly drive for work, since it allows mileage reimbursements to be paid 100% tax-free.

Once a company’s mobile workforce grows to five employees who regularly drive for work, a FAVR plan becomes a more cost-effective option. It provides a more accurate reimbursement by accounting for employees’ individualized costs; it eliminates over and under-reimbursements; and it allows reimbursements to be paid tax-free within IRS guidelines.

But oftentimes, it’s not a one-size-fits-all scenario. Companies tend to have a diversified workforce, with some employees practically living in their cars for work and other employees driving less frequently. Fortunately, it doesn’t have to be one mileage reimbursement program or the other. Combined cents-per-mile and FAVR programs adjust the reimbursement methodology based on employees’ driving behaviors. By combining the two and choosing a partner like Motus to manage both programs, companies can gain an optimized vehicle program that is tailored to their employee population and provides the most cost-effective and accurate reimbursements.

The Author

Danielle Lackey

As Chief Legal Officer, 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).

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