If you use a personal car for business reasons, your employer may provide a car allowance each month to cover those costs. But, many people wonder: Is a car allowance taxable income?
If you're wondering, "What is a car allowance?", you're not the only taxpayer who doesn't know. A car allowance is a set amount a company gives to employees to compensate them for using their car for work reasons. This can be paid on a monthly, quarterly or yearly basis. A car allowance is meant to cover travel expenses like wear-and-tear on your car, fuel and gasoline costs, repairs and more.
But a car allowance is meant to cover more than that. Generally, car allowances exist as compensation for every expense related to the employee’s operation and ownership of the vehicle while performing official company duties. Beyond maintenance and fuel, this should also include depreciation, insurance, and registration costs.
In a way, it’s akin to your employer leasing the vehicle, as they’re the ones who benefit from you using it. Every expense is also covered because they’re all essential to driving your car and, therefore, completing your job. In fact, almost every state requires employers to pay out car allowances when applicable.
Car allowances are set based only on the amount needed regardless of your car size. So, for example, if you own a van, but your job activities only require a sedan, then the car allowance should only cover costs for the sedan.
On the flip side, employees and employers should also ensure that the car allowance isn’t less than what the car needs. Again, this is where estimating the costs as closely as possible (with a little wiggle room) is beneficial. For instance, we mentioned that insurance and depreciation are included in this coverage. However, in reality, these cover more than half of car allowance costs, which many people fail to estimate properly.
Also, if the employee starts adding more miles due to work duties, it might be worthwhile to review and adjust the car allowance plan accordingly. Solutions like MileIQ’s mileage tracker app help by automatically logging miles driven for easier tracking.
Example: Josh is a traveling salesperson for Tables R Us. He receives $200 a month to compensate him for his use of his own car for his door-to-door sales. This amount doesn't change regardless of how many miles he drives.
Now, the next question is: are car allowances taxable?
So, is a car allowance taxable income? The answer is generally yes, unless you can prove to the IRS that it’s used for legitimate business purposes.
You can do this by tracking your vehicle mileage closely, then calculating the total cost using the standard mileage rate set by the IRS. This changes yearly, with the 2021 rate at 56 cents per mile and the 2022 rate at 58.5 cents per mile.
For example, let’s say that an employee got $200 per month as a car allowance in 2021. If they drive for 370 miles, that’s an equivalent of around $207, which is more than the allowance given and is therefore not taxable.
Tracking mileage this way is the requirement of an accountable plan. Car allowances under this plan are considered deductible expenses by the employer and are therefore not taxable to the employee.
If there’s no tracking involved that separates car expenses into personal and business use, it’s considered a non-accountable plan. Because it lacks such a separation of purpose, the IRS considers it taxable income.
Generally, the main draw of a non-accountable plan is that it’s easy for employers to determine since it requires very little administration and tracking. However, it comes at the expense of taxation, which costs both the employee and employer in the long run.
With an accountable plan, companies do not report car allowance and mileage reimbursement as pay. Make sure you and your employee are aware of how they're keeping track of your car allowance.
Now that we’ve answered the question of “is automobile allowance taxable?” there’s another issue that often pops up: “can I do a mileage deduction if I get a car allowance?”
People used to apply for a mileage deduction to offset the taxes applied on a non-accountable car allowance plan. While you could do this before 2018, changes to the tax law have eliminated this practice entirely.
However, it’s still important to track your mileage regardless. Obviously, if you’re on an accountable plan, you have to as a requirement. But even so, knowing your actual mileage can help determine if the car allowance amount can cover it.