How To Keep Car Allowance Tax-Free

When employers provide a car allowance, one of the most common concerns is how to minimize the tax burden. Employees are often left wondering why their allowance is taxed and at what rate. However, armed with the right knowledge, a car allowance can be kept tax-free altogether.

When do employers provide a car allowance?

Employers typically supply employees with a car allowance when they need to use a car as part of their work on a regular basis. Employees use this allowance to pay for fuel, maintenance, insurance, depreciation, and other expenses of using a personal car for work purposes. Although, in some cases, employees may use the allowance to rent or buy a car as well.

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When a car allowance is taxed

Employers can choose a number of different types of plans to provide their employees with a car allowance. The taxability of a car allowance depends on if it is an accountable or non-accountable car allowance plan.

Non-accountable plan

Many companies choose to use a non-accountable plan. If you choose this type of car allowance, you will pay a flat amount to your employees to help cover car expenses, which the employees can use as they please. With this type of plan, employees are not required to track their mileage or have expenses approved. Therefore, this type of car allowance is easy to use. But, if you use a non-accountable plan, the car allowance will be taxable as compensation, like wages. So, your employees are losing part of their car allowance to taxes.

Accountable plan

You could also choose to use an accountable plan for your employees’ car allowance, in which case, all substantiated parts of the car allowance will not be taxable. If you use an accountable plan for your employees’ car allowance, you will need to track your employees’ business mileage. Most companies track employee mileage by keeping a company mileage log.

A mileage tracker like Driversnote will be useful for this. This app can record your employees’ trips automatically and suggest the purpose of the trip. But, they can easily change the classification of the trip to ensure it is correct.

Standard mileage rate

One way to ensure you have a non-taxable car allowance is to verify your employees’ mileage for a certain period of time and then reimburse them. This allowance will not be taxable as long as it is not above the 2023 IRS standard mileage rate for business travel, which is 65.5 cents.

Fixed and variable allowance

Another option for providing your employees with a tax-free car allowance is to use a Fixed and Variable Allowance (FAVR). Although, your business does need to have five employees, each of whom drives over 5,000 miles a year, to use this allowance. You will also have to make sure you follow IRS regulations for the plan. A FAVR plan gives the employees periodic variable and fixed payments. The variable payment covers the operating expenses for the vehicle, such as fuel, oil, maintenance, and tires. At the same time, the fixed payment covers the fixed costs associated with a vehicle, including taxes, registration, license fees, insurance, and depreciation. The amount of these payments is based on location.

Car allowance

You could also provide your employees with a preset car allowance but track their mileage. Then, take the business mileage you have logged for an employee, and multiply this by the IRS standard mileage rate. Any portion of the employee car allowance that is less than or equal to this figure is not taxable. However, any portion above this figure is taxable.

For example, suppose you gave your employee a preset car allowance of $600 a month. Then, for the first month, their business mileage log shows that they drove 800 miles. You would multiply the 800 miles by the IRS standard business mileage rate of $0.655. This would give you $524. This means $524 of the allowance would be non-taxable, and $76 of the allowance would be taxable.

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How to provide a tax-free car allowance

You can provide your employees with a non-taxable car allowance by tracking your employees’ business mileage. To do this, your business needs to keep mileage logs that track all of the miles driven by employees for your business.

If your employees use their own car for work, they will need to track all of the miles they drive for business purposes and report this to your business. The easy way to track these miles is with a mileage tracking app that will automate the whole process and record all the required information.

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