How the Three Most Common Mileage Reimbursement Programs Can Impact a Business’ Taxesby
With business tax deadlines quickly approaching, companies have to consider several factors before filing. For example, as the various implications associated with business vehicle program taxes are taken into account for mileage from last year, sound policies and programs can be instituted to ensure that the organization is in the best position come tax time next year.
There are a wide range of business vehicle programs, each with its own set of tax considerations. Compliance stipulations and tax implications can either be a burden or benefit, depending on an organization’s objectives and needs.
With certain business vehicle programs, reimbursements must be reported as taxable income, which increases total payroll tax withholdings and lowers an employee’s take-home amount. For example, flat allowances, which offer business drivers a monthly fixed-dollar amount that’s added to their monthly paycheck, are the most straightforward to implement, but are subject to income taxes.
At larger organizations where drivers’ business mileage amounts and geographies differ vastly, a fixed and variable rate (FAVR) program might be a more accurate and viable option – and it’s tax-free. Qualifying for tax-free programs requires thorough oversight, accurate mileage, and an understanding of IRS and administrative requirements to create valuable tax advantages.
There are pros and cons to both taxable and tax-exempt reimbursement programs, so other factors, like a business’ driving needs and current patterns, must be carefully considered in choosing the appropriate plan. Tax season is the opportune time for an organization to evaluate its current vehicle program and to look ahead at opportunities to improve results.
Business leaders must familiarize themselves with the tax liabilities associated with the different programs to ensure their organizations are protected by choosing the most financially conscious option.
Here are three types of reimbursement programs and the specific tax implications associated with each:
1. Flat allowances. A car allowance is the most clear-cut of the three, and it’s the easiest to administer. However, it also poses the most significant tax burden to both employers and employees. A company with 100 drivers, with an allowance of $800 monthly, can lose up to $364,800 in taxes alone. Allowances are considered income and subject to payroll taxes, so a driver’s earnings are significantly reduced.
To account for dollars lost in taxes, businesses would need to add as much as 30 percent to the allowance to ensure drivers take home a specific dollar amount. For businesses with drivers who are geographically dispersed, a flat allowance program can create discrepancies in reimbursement fairness.
For example, the insurance cost difference between Detroit and Atlanta is $4,000. The business driver in Atlanta may be overreimbursed because of his or her low insurance costs. Meanwhile, the driver in Detroit, where it is more expensive to own and operate a vehicle for business, could be underreimbursed.
2. Cents per mile. This type of reimbursement program is used by nearly 80 percent of organizations for at least a portion of employees. Cents-per-mile (CPM) programs reimburse drivers at either the IRS standard deduction rate or an internally developed custom rate, and they are best suited for participants who drive fewer than 5,000 miles annually.
A CPM program calls for thorough reporting requirements in order to be tax-free, such as detailed and accurate mileage logs. Drivers must capture and record business mileage data, such as each trip’s start and end location, time, date, travel purpose, and more. In addition, employers are required to keep archives of these travel logs for seven years.
And though it seems the responsibility lies in the employee’s hands, the audit trail can shift from the driver to the employer. Manual mileage logs open a company up to audit risk and also spending more than is required on reimbursements due to mileage estimates and inaccurate online tools. Mileage capture can save businesses up to 15 percent on reimbursement alone.
The IRS safe-harbor rate, which is a common figure used for CPM programs, is based on averages, so it does not accurately reflect geographical variables in the cost. CPM programs can underreimburse drivers in expensive markets, like San Francisco or New York City, while significantly overreimbursing high-mileage drivers.
3. FAVR. FAVR programs reimburse drivers for the fixed costs of owning and operating a vehicle, such as insurance, taxes, and depreciation, in addition to variable costs, like fuel and maintenance, which differ based on location.
Because these programs are so dynamic, they are considered a first-rate option. And aside from being flexible and customizable, FAVR programs can also be tax-free to businesses and employees. Though it offers many of the same benefits as an allowance plan, the expense ratio can be up to 40 percent lower for FAVR programs. FAVR programs consider regional cost differences, which in conjunction with other factors, can save businesses nearly $3,000 per driver.
Employers must meet a set of IRS requirements in order for their FAVR program to be tax-advantaged. This includes having five or more drivers who drive at least 5,000 miles each annually.
Business vehicle programs aren’t one size fits all. Each has its own benefits and drawbacks that need to be examined by an organization’s leaders. By establishing a strong understanding of business driving needs, businesses can make a well-informed decision about the appropriate reimbursement program(s), improving the bottom line and ensuring fair and accurate reimbursement for employees.
In light of tax season, employers can take this time to closely evaluate their tax implications to understand the impact of their current program and, from there, make a decision for moving forward.
Donna Koppensteiner is senior vice president of business development at Runzheimer, a business vehicle, relocation information, and expense management services provider that provides data research and analytics to the IRS.