Understanding What Is Car Allowance: A Comprehensive 2024 Breakdown
A car allowance is a monthly cash benefit a company adds to employees’ salaries instead of providing them with company vehicles. Its role is to offset various expenses, which may include car rental or lease fees, gas, costs of maintaining a private vehicle, as well as insurance and depreciation.
Ostensibly, providing employees with a car allowance gives them more flexibility in managing work-related travel and expenses. Knowing the fixed amount they receive for a given period, they can choose whether to get a new car for work or use the money to cover the expenses of their personal vehicle.
Of course, if the fixed amount is not sufficient for an employee who drives long distances, a car allowance may not be an adequate form of reimbursement.
As opposed to tax-free cents-per-mile reimbursement, a car allowance is considered income, and it’s fully taxable. Despite that, it’s still preferred by some companies as it makes the compensation process more straightforward.
How car allowance works
Car allowance, also known as a vehicle allowance, is a form of employee compensation for using a personal vehicle for work-related activities. Here’s how it works in action:
Let’s say you’ve landed a job that requires travel. The company adds a monthly allowance to your salary to cover the costs of work travel so you’re not forced to pay for them out-of-pocket. Depending on your preferences, you can spend the allowance on maintaining your personal car or lease one. Usually, this reimbursement method doesn’t require you to provide any documentation to the employer or the IRS, as it’s considered a part of taxable income.
Most states don’t have regulations regarding vehicle reimbursements so the exact amount for car allowance is set by each individual company. Usually, companies try to estimate approximate mileage for a specific position.
The exceptions are California, Illinois, and Massachusetts, where employers are required to reimburse employees for work-related expenses, including using a vehicle for business purposes.
What costs are covered by a car allowance
Every business can create its own policies around car allowance. Generally speaking, a car allowance is meant to cover the costs of business-related driving. If you’re using a personal vehicle that may include:
- insurance premiums
- replacement parts
- depreciation
- parking fees
- fuel
- maintenance
However, the exact costs will vary by industry or position — for example, if extensive travel is required, a car allowance may focus on covering rentals.
How to calculate car allowance?
There are no federal guidelines for employee car allowance, so companies are free to create their own rules. However, if you’re thinking about introducing a car allowance policy for your organization, there are factors that you should consider.
- Job requirements: The nature of the job and the expected use of a vehicle for work is the most crucial factor. If you’re able to determine the approximate mileage required for a specific position, it should make your calculations easier.
- Industry standards: It’s good to know how your competitors approach reimbursing employees to keep up with the trends and remain competitive in the job market. Employees and candidates will take notice.
- Cost of vehicle ownership and working conditions: Various ever-changing costs of vehicle ownership, such as insurance, should always play a role. On top of that, in some professions, you may want to consider difficult working conditions, like frequent off-road driving to job sites.
Staying up to date (with everything): Remember that your car allowance policy is never final. Or at least, it shouldn’t be. From time to time, you should analyze how much your employees need to spend on travel and adjust accordingly. You may also take into account factors like fuel cost and inflation.
Tax implications of car allowances
Car allowances are taxable income, so they’re subject to state and federal taxes. It means that around 30-45% of the original amount goes to the IRS. So, if your monthly car allowance is $500, only around $300-$350 actually goes into your pocket.
It’s one of the biggest reasons businesses reimburse their employees via other methods, such as the cents-per-mile (CPM) method or FAVR. In some cases, they combine allowance with tax-free CPM reimbursements.
Car allowance for employers
In its simplest form, a car allowance is a fixed amount that’s considered a part of an employee’s income. Usually, every month or every two weeks, you add a certain amount of money to an employee’s salary to cover work travel expenses.
This non-accountable model is very easy to introduce and manage but isn’t optimal from a tax standpoint.
It is possible to introduce tax-free car allowance using the Fixed and Variable Rate method. However, it takes much more effort and requires a company to have at least 5 employees who drive more than 5,000 miles each year.
Car allowance for employees
If you’re an employee, a car allowance is simply an addition to your salary that you can use to cover business travel expenses though, you don’t need to track mileage or collect receipts.
On the other hand, you may want to analyze from time to time if the allowance you receive is sufficiently given all your travel expenses, including not only gas but other costs of vehicle ownership.
You should also remember that your car allowance is fully taxable, so there’s a chance that you could get more money if you switched to mileage tracking and used the cents-per-mile method to get tax-free reimbursements. It may potentially be a win-win situation for both you and your employer.
Alternatives to car allowance
Three of the most common reimbursement alternatives to car allowance are:
- Cents-per-mile (CPM) reimbursements
- Fixed and Variable Rate FAVR
- Mileage allowances
Each program has its own unique features, and all of them can be viable depending on the company and travel requirements for a specific position.
Cents-per-mile (CPM) Reimbursement
The CPM method allows for completely tax-free reimbursements as long the reimbursements are at or below the standard IRS mileage rate, (67 cents per mile in 2024).
It requires drivers to track their business mileage and submit mileage reports to their employer, including the date, purpose, start and end locations, and distance for each trip, either on paper or in a digital mileage log.
While the pen-and-paper method can still be viable on a smaller scale, it quickly becomes time-consuming and prone to errors. Mileage tracking apps like MileIQ are much more convenient as they capture and collect all necessary information for review and then prepare it in the IRS-ready format.
The CPM method can feel more in touch with actual expenses since drivers are reimbursed directly for miles on the road, and the IRS updates rates regularly to account for changes in the economy, including gas prices, insurance, inflation, and more.
Fixed and Variable Rate (FAVR)
The other popular reimbursement method is Fixed and Variable Rate, which is a hybrid model that combines mileage tracking and calculating expenses. It’s considered the most accurate method of vehicle reimbursement as it takes into account the actual operating expenses of a vehicle.
FAVR programs consider geographic variances, ensuring reimbursement rates are adjusted for location-specific costs such as taxes, insurance premiums, and fuel prices. Moreover, if the substantiated mileage does not exceed the preset car allowance, the difference can be non-taxable, aligning with IRS regulations.
The one downside of this method is that it’s relatively difficult to implement and manage. It requires mileage tracking in addition to other thorough documentation to ensure everything is fair and square with the IRS.
Car Allowance vs. FAVR vs. CPM: Advantages and Disadvantages
How about a company car?
While it’s not one of the compensation methods, a company car deserves a mention. It serves the same purpose, after all.
A company car is usually the most convenient method from an employee’s perspective. It can significantly reduce employee car expenses as they may not have to pay for gas, maintenance, or insurance for business use. On top of that, it’s considered a status symbol and may be quite attractive as an element of a recruitment pitch for your company.
Of course, it all comes with considerable costs on the part of the employer, including purchasing/leasing costs, maintenance, repairs, insurance, and fuel.
Key Points
Car allowance is a fairly straightforward way to compensate employees for business travel expenses. There’s no need to track or submit mileage records or do calculations. California, Massachusetts, and Illinois require workers to be compensated for work-related expenses, but other than that, employers have complete flexibility in creating their car allowance policies
However, car allowances are considered taxable income and employers can’t deduct car allowance amounts as business expenses on tax returns. Car allowances can also become insufficient in covering expenses if not adjusted regularly.
So, remember, the key to a successful car allowance policy lies in striking a balance between the needs of the employee and the financial realities of the company.
Still tracking miles by hand?
FAQ