Employees and business owners need to be aware of the potential tax implications of the reimbursement of mileage expenses.
With the high gas prices these days, the last thing you need is a big surprise when it’s time to prepare your tax return. It’s best to get a handle of the IRS rules surrounding business travel earlier in the year so you understand the impact before tax time at year end.
It’s important to know the 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 the payments will be considered compensation and you will pay both payroll and income taxes on the amounts received (just like regular wages).
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 an expense report 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 2023, the new rate is 65.5 cents per mile, up 3 cents from the last increase.
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
For example, if the standard IRS mileage rate is 65.5 cents per business mile, and your employer pays you at a 70 cents per mile rate, the 4.5 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 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!
Non-accountable Plans vs Accountable Plans
The IRS defines both a non-accountable plan and an accountable plan. These are important differences as it impacts 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 in a reasonable period of time
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.
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. If you fail to meet all three items required for an accountable plan, you by default have a non-accountable plan.
Payments made to you by your employer under a non-accountable plan 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. In other words, if you don’t keep records to substantiate your reimbursed employee business expenses it will by default be considered compensation to you.
FAVR (Fixed and Variable Rate)
The standard IRS mileage is based off of a national average. What happens if you live in a higher cost city and your fuel and other car expenses are much higher? You would be taking a loss by using your personal vehicle for work purposes.
The FAVR (Fixed and Variable Rate) plan is a more accurate way to calculate an employees’ auto business expenses. It breaks down your auto expenses in two components. One is for your Fixed vehicle costs (depreciation, insurance, registration fees) based on the make and model of your vehicle. The other is to reimburse you for your variable vehicle expenses (fuel, maintenance) based on where you are located.
Under this plan an employee will typically get a flat payment each month to cover the fixed costs calculated based on your make and model of vehicle. The variable costs are based on fuel costs in your area, and are often updated monthly. Your employer will typically give you an updated mileage rate each month to use when submitting your expense report.
The IRS has strict rules in order for FAVR to be non-taxable. If your employer elects this method you will likely need an independent service to provide the fixed and variable rates as well as accurate tracking of your business miles often using a GPS tracking service.
Company Car
So far we’ve discussed driving your own car an an employee for business purposes. But what if you are given a company car? What are the tax ramifications then?
The specific rules are different, but in the end the concept is the same. You don’t pay tax for the business use portion. You pay tax on the personal use portion of the company vehicle.
The calculation is sometimes called PUCA (Personal Use of a Company Auto) or PUCC (Personal Use of a Company Car).
IRS publication 15-B provides the calculation methods available to businesses to determine the the non work-related expenses taxable to the employee as a fringe benefit.
The methods available are the General Valuation Rule, the Cents Per Mile Rule, and the Commuting Rule. All of the specifics and exceptions are included in the IRS publication. Each of these rules has detailed guidelines to follow. The goal is to come up with a fair calculation of the value of the personal use portion. The amount calculated as the personal portion is considered a taxable fringe benefit and is included in the payroll process and reporting on form W-2 at year end.
Monthly Allowance
If you are given a car allowance for your personal vehicle, such as a flat dollar amount per month, 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 giving you a monthly bonus.
The company is basically just giving you compensation called 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.
Minimum Wage
As discussed earlier, the IRS has set the latest mileage rate for the second half of 2022 at 62.5 cents per mile. That is the best estimate nationwide that it would cost per mile to drive the average vehicle. So how does that relate to the minimum wage?
Employees performing deliveries in their personal vehicles would be a good example. If you are paid by the hour or by the delivery but not reimbursed for your vehicle expenses, it’s possible that after you subtract those costs you could effectively be making less than minimum wage. It’s also possible that you could even be losing money!
For example, let’s say you work 8 hours performing deliveries in your own car and you get paid $15 an hour to do so. At the end of the day you would have earned $120 (8 hours x $15/hr). However, you drove your own car 120 miles to make the deliveries. At 62.5 cents per mile your car expenses would be $75 (120 miles x 62.5 cents).
Your final true net earnings for the day would end up being $45 ($120 less $75). Your new effective hourly rate would then be $5.63 per hour ($45 / 8 hours), which is below the federal minimum wage of $7.25 per hour. If that was the case, you would have a legal claim against your employer to cover the gap to get your pay back up to the minimum wage.
Understand that the IRS mileage rate is a good approximation of your vehicle costs. That is real money even though you can’t see it. For example, depreciation (loss in your car value) is not as visible as you paying to fill up your gas tank.
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.
Use tools to make it easier to track your mileage
You can track your mileage manually by writing down 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 make it much easier to track the mileage. Check out these apps that help do the tracking for you.
Summary: Employee guide to taxable mileage expense reimbursement
- The IRS standard mileage rate is a very common program resulting in tax free reimbursement of business expenses
- Payments received in excess of the standard mileage rate will be subject to payroll and income taxes
- The FAVR (Fixed and Variable Rate) option is probably the most accurate method of reimbursement as it takes into consideration your actual vehicle and location. The rules are strict and specific in order to maintain tax free reimbursement under this option.
- Without an accountable plan, the entire amount will be considered income and not a reimbursement of expenses.
- If you have a company car there will be a calculation performed to determine your percentage of personal use and the taxable amount
- A flat monthly allowance given to you for your car is taxable income just like wages
- If you are not being reimbursed or compensated for your business mileage it is possible that you could effectively be making less than the minimum wage.
- 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 GPS tracking tools and mobile apps tools to assist in the documentation of business mileage.
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