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Car allowance policy: What your business needs to know

If your business has employees who use personal vehicles for work reasons, you may consider a car allowance policy. Let’s go over what this means and how you can decide if it’s the right move for your organization.

How does a car allowance policy work

A car allowance policy is when the employee provides a flat rate (often per month) to compensate employees for using their vehicles. Often, this is an agreed-upon amount that applies equally to employees.

For example, Sales-R-Us could offer a $200 monthly car allowance to its outside sales team. This would apply to sales workers no matter how far they drive each month.

On the positive side, a car allowance policy is very simple to maintain. It also may have fewer tax implications than a company car. On the downside, businesses may not be getting the most effective ROI from a car allowance policy.

When is a car allowance taxable?

A car allowance policy is generally considered taxable income. For the business, a car allowance is subject to FICA taxes, as well.

What rules should your car allowance policy have?

You should tailor your car allowance policy to fit your business needs. Start by calculating how much your employees typically drive. You can use the standard mileage rate of 53.5 cents per business mile as a baseline figure.

I’d also suggest asking some trusted field team members about what they believe is a fair car allowance amount. Randomly choosing a figure may be easier but it’s not the best way to really hone in on a rate that makes everybody happy. Don’t forget to revisit your amount every year, as well.

Downsides of a car allowance policy

A car allowance policy’s biggest virtue is its simplicity. Once you agree to a dollar figure, you just add that to eligible employees’ payroll. You may revisit it once a quarter or on an annual basis, but you’re pretty much done.

Using this method has multiple downsides, though. These include:

  • Taxes: A car allowance policy can add more taxes to the employee in the form of more taxable income. There are also additional FICA taxes to pay for the employer.
  • Inefficient: You’re not maximizing your dollars. A flat rate means you’re allocating resources to something you don’t know you’re getting the most value for. This could be worth thousands of dollars a year.
  • Poor Incentives: A flat-rate policy may unintentionally provide bad incentives for employees. It benefits workers to drive as little as possible to get the most out of their flat-rate allowance.

A car allowance or mileage reimbursement

You’ll likely want to consider a car allowance policy vs. mileage reimbursement. Mileage reimbursement is when the business reimburses employees for the costs of using their vehicle for work.

Mileage reimbursement does require more record-keeping. Employees have to keep a detailed logbook and employers have to calculate and maintain reimbursements every month. But, with tools like MileIQ for Teams, businesses can implement a mileage reimbursement policy with ease.

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The Growth Center does not constitute professional tax or financial advice. You should contact your own tax or financial professional to discuss your situation.