As an employee, you should be aware of the potential tax implications of receiving a flat-rate car allowance for work.
With higher gas prices and other vehicle costs these days, the last thing you need is to pay more taxes than you need to. It’s best to get a handle of the IRS rules surrounding business travel so you can understand the impact to your finances.
There is an important difference between expense reimbursement and compensation. If you meet the rules for expense reimbursement up to the limits, your payments received will be non-taxable. If you don’t meet the rules for reimbursement, all the payments will be considered compensation and you will pay both payroll and income taxes on the amounts received (just like regular wages).
Monthly Car Allowance
If you are given a car allowance for your personal vehicle, such as a flat dollar amount per month, without any business miles being recorded, it is considered extra pay by the IRS and is subject to both payroll taxes and income taxes. In other words, it is no different than getting a monthly bonus.
In this example the company is just giving you compensation and calling it a “car allowance.” They could call it whatever they want. It doesn’t really matter. It is just normal compensation and it’s taxable to you.
For example, if you company pays you a $500 car allowance every month, that is taxable income and will be subject to state and federal income taxes.
Are you leaving money on the table?
If you are getting a flat amount per month in the form of a car allowance without any business mileage tracking (Non-accountable Plan), and you use your car for any business travel, you are definitely leaving money on the table in the form of additional taxes.
You are leaving money on the table because the IRS allows for the tax free reimbursement of business mileage up to the standard mileage reimbursement rate. Starting in 2024, that rate is 67 cents per mile.
How much money are you leaving on the table?
Employers that have a basic car allowance program, without any mileage tracking, likely do so because it is quick and easy.
A benefit is still a benefit, but the real value for you is the net value after taxes.
So, for example, if you are getting a $500 a month as a car allowance not in an accountable plan (defined below), you will be taxed on $6,000 of additional compensation for the year ($500 x 12 months). That would include the federal income tax, state income tax and payroll taxes.
Using some estimated numbers of a 24% federal tax rate and a 6% state tax rate gets you to 30% for income taxes. Then, you also have 7.65% in payroll taxes (social security and medicare taxes), assuming you don’t hit the social security maximum. That totals 37.65% in taxes overall, or $2,259 in taxes for this example ($6,000 x 37.65% = $2,259). So, your $6,000 car allowance is really worth $3,741, net of taxes ($6,000 – $2,259).
That is not good or bad on face value. We need more information to decide if it’s a fair deal.
First, how does it compare to competing plans at other employers? You would need more information from others to make that determination.
Second, how many miles did you actually drive for business, which excludes your personal commutes to and from work? For example, if you drove 3,000 miles for the year for business, the IRS would allow $2,010 in tax free reimbursement (3,000 miles x 67cents/mile = $2,010) under an accountable plan. If you received $3,741 net of taxes on a car allowance program, you still came out ahead.
Breakeven point
In this example, the breakeven point would be 5,584 business miles in a year ($3,741 / $0.67 per mile = 5,584 miles). In other words, if you drive less than that for business you are ahead using the flat rate car allowance, but more than that you are behind.
You can figure out this mileage breakeven point for your own situation by taking your annual car allowance, net of taxes and dividing that by the IRS 67 cents-per-mile rate. How does that compare to your actual or expected business mileage?
Accountable plan maximizes your allowance
Of course if the employer has an accountable plan (defined below), you would maximize your benefit because you would get full reimbursement for all business miles at the IRS rate of 67 cents per mile, with only the excess car allowance above that being taxable.
Using our 3,000 annual business miles example, that would exclude $2,010 of the car allowance as a tax free reimbursement of business mileage. Only the $3,990 excess ($6,000 – $2,010) would be subject to taxes. Using the same example 37.65% total tax rate, your tax would be $1,502 ($3,990 x 37.65%). This means you would save $757 ($2,259 – $1,502 = $757) in taxes, just by tracking business mileage under an accountable plan.
Would could you do with another $757 in your pocket in this example?
Non-accountable Plans vs Accountable Plans
The IRS defines both a non-accountable plan and an accountable plan. These are important differences that impact whether or not taxes are due.
Under accountable plan rules, the IRS has the following requirements as defined in IRS Publication 463 (Travel, Gift and Car Expenses).
- Your expenses must have a business connection (not personal)
- You must keep records (mileage log) and provide that to your employer in a reasonable period of time
- You must return any excess reimbursements or advances in a reasonable period of time or that portion would be taxable
If you follow these rules under an accountable plan, you won’t owe any taxes on the reimbursements. You are just recovering costs from your employer for your business-related expenses. Tracking your business miles and turning in your expense report for the standard mileage reimbursement is an example of an accountable plan. Item #3 above refers to the taxable portion, which would be the car allowance in excess of the substantiated business mileage.
Under a non-accountable plan, your employer pays you amounts to compensate you for your expenses, but you don’t meet all the requirements of an accountable plan. In other words, you don’t keep records to substantiate that your auto expenses are business related or you don’t keep track of your mileage.
Payments made to you by your employer that are not allowable reimbursements are considered gross income. This is reported in Box 1 of your W-2 at year end. These payments are also subject to payroll taxes such as FICA and Medicare.
Standard mileage reimbursement
As a general rule, if as an employee you drive for business purposes with your own car, you qualify for the reimbursement of travel expenses. This does not include your normal commute from your home to and from work, which is considered personal mileage.
A best practice for expense reimbursement is for the employee to submit expense reports to their employer for their business mileage. The employer then reviews and reimburses the employee for mileage incurred in accordance with the company mileage reimbursement policy.
It’s typical for employee mileage reimbursements to be at the standard mileage reimbursement rate as provided by the Internal revenue service (IRS). The IRS provides the standard rate each calendar year. When auto expenses are more volatile, the IRS may announce a mid year change to the rate.
For example, in 2022, the standard mileage rate to start the year was 58.5 cents per mile. Due to the spike in fuel prices, the IRS announced a mid-year increase of the rate to 62.5 cents per mile effective July 1, 2022. For 2024, the new rate is 67 cents per mile, up 1.5 cents, or 2.3% from the last increase in 2023.
Your employer determines what your mileage reimbursement rate is going to be. It will be defined in your company’s mileage reimbursement policy. If the reimbursement amount is at the standard IRS, there won’t be any tax implications. However, if your employer reimburses you at a higher rate, the excess will be considered taxable income for you. In other words, your company is paying you more than what the IRS determines is the cost per mile. It is therefore considered compensation.
Example reimbursement vs the standard mileage rate
For example, if the standard IRS mileage rate is 67 cents per business mile, and your employer pays you at a 70 cents per mile rate, the 3 cents excess reimbursement will be considered taxable income subject to both payroll and income taxes. These excess cost payments are considered fringe benefits and will be on your W-2 at year end.
If you are paid less than the IRS standard mileage you will take a loss on the shortage. In addition, the current tax law does not let you take a tax deduction for the shortfall. In this case it is fair to ask your employer why they don’t make you whole for your business mileage!
State Laws
In addition to the federal laws, some states have their own unique rules regarding business expense reimbursements. The states of California, Illinois, and Massachusetts, for example, require that employers reimburse employees for their business mileage.
This is supposed to ensure that employees do not eat vehicle costs related to business. That being said, most companies fully reimburse their employees anyway to stay competitive in the marketplace.
Mileage Logs
You can track your mileage manually by writing down the purpose of the trip and your odometer reading at the beginning and end of each business related trip. The difference would be the business mileage that would then be reported to your employer for reimbursement. Doing this manually can be slow and tedious.
Another option is to use a mobile app that makes it much easier to track the mileage. Check out these apps that help do the tracking for you.
Executive Summary: Taxes Due when receiving a car allowance for work
- Getting a set amount car allowance without any business mileage tracking will make the amount received subject to both income and payroll taxes, just like regular wage income
- Business travel using your own vehicle does not include your normal daily commute to and from work
- Under a non-accountable plan you don’t track your business mileage, and under an accountable plan you do
- Tracking your business mileage under an accountable plan allows you to exclude the qualifying costs (mileage x IRS allowed rate) as a non-taxable reimbursement
- The new IRS business cents-per-mile rate for 2024 is 67 cents per mile
- Generally speaking, companies are not required to reimburse you for your business mileage unless you are in a state that requires it
- You can use manual logs or GPS tracking tools and mobile apps tools to assist in the documentation of the business purpose and mileage.
