Car Allowance vs Mileage Reimbursement: What Is the Best Choice for Your Business
Car allowance and mileage reimbursement are two very different methods of compensation for employees using their vehicles for work purposes. Car allowance is a flat payment added to salary regardless of distance traveled, and mileage reimbursement is based precisely on, you guessed it, mileage.
The first option is straightforward to implement and manage, even at a big company. Car allowance is easily executed and predictable months in advance, so it’s easy to budget. However, the entire amount is taxable, so it might not be optimal if transportation makes up a large portion of your business expenses which could otherwise be deducted.
Mileage reimbursement, on the other hand, is based on distance traveled and can be entirely tax-free if reimbursements are calculated using the standard mileage rate set by the IRS. In this model, employees must track and report their mileage to prove that each trip is eligible for tax-free reimbursement.
How does car allowance work?
A car, or a vehicle allowance, is a fixed sum paid periodically to employees to cover the cost of their business-related travel. This amount remains steady regardless of how many miles an employee covers and is usually added to the employee’s paycheck.
The biggest advantage to this approach is simplicity. It’s easy to administer and budget for. And it offers employees flexibility to spend their budget according to their preferences. They can use it to lease a car, rent one, or spend the money on gas and maintenance for therown vehicle.
However, a car allowance is considered taxable income, so both employers and employees may miss out on tax benefits. Additionally, since it’s a flat payment, a car allowance may not align with daily realities of every driver on the team.Those who cover fewer miles may benefit more than those who drive long distances.
How does mileage reimbursement work?
Mileage reimbursement is based on distance traveled. These reimbursements can be entirely tax-free, but drivers need to track mileage and record details about each business trip. Mileage is considered a deductible expense, so record-keeping is essential if you plan to deduct it on your tax return.
There are two common methods for calculating mileage reimbursement:
- the Cents-Per-Mile (CPM) method, which is based on a predetermined rate set by the IRS,
- the actual expenses method, where employees track mileage and submit receipts for all car-related expenses.
Regardless of the exact calculation method, mileage reimbursement is often more accurate, since it compensates each driver individually for miles covered, instead of using a ball-park figure to cover business travel expenses.
It also leads to a lower tax burden for employees, as reimbursements can be tax-free as long as they’re backed by thorough documentation.
However, it does increase the administrative burden because more record-keeping is required. Using mileage tracking apps is a great way to automate some of the admin tasks related to mileage reimbursement, including tracking drives, calculating mileage, and managing approvals.
Car allowance vs. mileage reimbursement for employees
From an employee’s perspective, car allowance and mileage reimbursement have unique pros and cons. A car allowance offers predictability and flexibility. Regardless of whether you drive a lot or a little for work, you receive the same amount each pay period. But perhaps the most important benefit of a car allowance is that it can be used entirely according to employee’s preferences. You may use it to lease, rent a new car, or spend it on your own vehicle. On the other hand, an allowance amount that might feel very generous to some employees, could be insufficient for others, especially if they spend more time on the road. It’s also taxed like regular income, which means employees will not get to keep the full allowance amount listed on their paycheck. Mileage reimbursement is tailored to each individual employee’s driving volume, and thus can feel more fair, though it does require tracking drives and submitting reports — which can be done automatically with mileage tracking apps, like MileIQ. When the reimbursement rate is at or below the standard set by the IRS, it’s also tax-free, meaning employees get to keep the full amount.
Car allowance vs. mileage reimbursement for employer
From an employer’s perspective, the decision between car allowance or mileage reimbursement often depends on three factors:
- administrative capabilities
- industry standards
- employees’ transportation needs and expectations
A car allowance program can be simpler to administer,since it’s a fixed cost, regardless of how many miles an employee drives. This makes budgeting easier and reduces the need for extensive record-keeping.
However, the simplicity comes with potential downsides. There’s a chance you will overcompensate those who drive less, leading to unnecessary expenses. At the same time, another group of employees who drive frequently may be dissatisfied with their car allowance. A car allowance is also taxed, which means you wouldn’t be able to claim it as a business deduction.
That’s why a good car allowance program shouldn’t be set in stone. Businesses should be aware of changing circumstances, including rising costs of vehicle ownership and employees’ needs for transportation over time.
Mileage reimbursement has the inverse benefits and drawbacks — it’s somewhat harder to administer because of additional record-keeping but better reflects real expenses of employees.
Here’s a quick summary of the pros and cons of both options.
Car allowance vs. mileage reimbursement — tax implications
From the tax perspective, mileage reimbursement and car allowance are two fundamentally different options. The first one is usually treated as a portion of income and it’s subject to state and federal taxes, and the other can be totally tax-free if reimbursed using the IRS cents-per-mile (CPM) rate.
Car allowance tax implications
Car allowance plans are usually non-accountable. Employees simply receive a lump sum on their paycheck and are not required to track mileage or have expenses approved.
It means that the compensation is treated similarly to wages and is taxed exactly the same way.
However, car allowances can be non-taxable if they adhere to an accountable plan. Here’s how it works:
- Employees track business mileage and substantiate their expenses.
- The non-taxable portion of a car allowance is limited to the business miles driven multiplied by the IRS CPM rate, which is 67 cents per mile for 2024.
- Any excess is taxable at the normal income rate.
Mileage reimbursement tax implications
Mileage reimbursements, on the other hand, are typically non-taxable as long as the reimbursement rate does not exceed the IRS CPM business rate, which is $0.67 for 2024. However, to maintain this non-taxable status, businesses must demonstrate that the mileage driven is for business purposes and maintain up-to-date records of each business trip.
If an employer pays a mileage rate higher than the IRS CPM rate, the excess amount is considered taxable income. Moreover, if an employer pays the standard rate or less but fails to keep proper business mileage records, the IRS may issue penalties or request an audit.
Calculating costs and savings
While mileage reimbursement is generally considered more accurate and optimal from the tax standpoint than car allowance, businesses often avoid this solution due to potential issues with implementation and the costs of running such a program. Especially for smaller companies, a car allowance program was always an easy alternative.
However, with the help of apps like MileIQ, the entire process has been simplified, so even small businesses can easily launch their own mileage reimbursement programs. All the steps, including tracking, calculating, and reporting, become much more automated and less prone to human error.
In a way, the car allowance program becomes a more tricky option as businesses have to use their experience and historical data to estimate the accurate allowance amount for their employees
Example calculations for employers
A company chooses to offer a car allowance. By estimating monthly travel needs for a certain position, they set the allowance at $400 before taxes. An employee will receive about 30-40% less ($280-$240) after taxes as a bonus to their salary, and that’s the end of the story. The question if the compensation is accurate depends entirely on their monthly mileage.
A similar company decides on mileage reimbursements and uses the 2024 IRS standard rate. In that case, the calculation looks like this:
Which means they would receive $33.50 and get to keep the full amount. Provided that the trip is tracked and properly recorded, the business can claim this mileage as a deductible expense on their tax return.
Employees: How to make the most of either car allowance or a mileage reimbursement
If you’re receiving a car allowance, it doesn’t hurt to still track your mileage. By understanding exactly how much you drive for business reasons, you may estimate if your car allowance is fair or not. And if you decide that you should receive larger compensation, by tracking and recording business mileage, you can show your employer proof and negotiate a higher allowance.
And in the case of mileage reimbursement, the best advice is to track every business mile. Even the shortest trips gradually stack up to quite a considerable amount of money.
Car allowance vs. mileage reimbursement —which to choose?
The answer will depend on your business, industry, and resources, however mileage reimbursement is often preferred, especially since much of the administrative work can be eliminated through automation. Still, the simplicity of car allowance can be very appealing to many companies.
Ultimately, the best choice will depend on your unique business needs.
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