When an employee who uses a personal vehicle to do his job receives compensation, the employer also benefits. Using a car for business purposes can be costly. Even averaging 100 miles per month means several hundred dollars in expenses over the course of a year. Some employers are willing to pick up the tab in order to attract and keep the qualified people they must have to be successful.. There are two widely used models for compensating employees for the use of their own cars: the car allowance and mileage reimbursement.
A company car allowance is a predetermined sum paid to an employee as compensation for driving his or her own vehicle for business reasons. MileIQ says companies use car allowances to minimize accounting costs. Once an employee has been allocated a car allowance, that amount is simply added to the employee's paycheck. For example, if the car allowance is $500 per month, this sum is paid to the employee via his or her paycheck.
Employers rely on two estimates to determine how much a car allowance should be. The first is the number of business-related miles an employee drives; the second is the cost of operating a personal vehicle. The goal is to determine the vehicle's operating costs, starting with the cost of gas. The company then adds expenditures for insurance, taxes, maintenance, repairs and depreciation. The result is converted to a rate per mile and multiplied by the mileage estimate. This is essentially the same procedure that the Internal Revenue Service uses to set its standard mileage rate for the business use of vehicles. Consequently, the average car allowance is about the same as the IRS standard mileage rate. However, the cost to a company of paying a car allowance is higher than it is when a mileage reimbursement model is used and the employee ends up with less money after taxes according to Motus.
The IRS considers car allowances to be income that is taxable to the employee in the same way his salary is taxable. This means that companies also must pay applicable taxes on the amount, such as the employer portion of Social Security tax. In contrast, a mileage reimbursement is classified as a business expense. The employee pays no income tax or other taxes on the money, and the employer does not pay payroll taxes. If an employee receives no compensation for business driving, he can deduct the mileage at the standard IRS rate. This rate was set at 54.5 cents per mile for tax year 2018.
When a company pays a mileage reimbursement instead of a car allowance, the IRS rules set limitations and documentation requirements that do not apply to allowances. The employee must keep a mileage log that includes odometer readings along with the purpose and destination of each business trip. Only travel for purely business reasons is eligible – commuting to and from work is not qualified mileage. Because mileage reimbursements are not taxable income, the employee ends up with more money compared to the after-tax amount of a car allowance.