What’s the Best Way to Reimburse Employees for Mileage Expenses?
Using an Allowance vs. Reimbursement
What's the best way to reimburse employees for their business driving? The answer depends on your own business needs and income tax regulations. The two payment options are reimbursement or a car allowance.
Taxes and Your Business Driving System
Before you begin paying employees for driving expenses, you will need to consider the tax implications of your decisions. Your expenses relating to employee business driving are deductible to your business, but you must be able to prove these expenses, so you’ll need a system that requires employees to report driving costs.
Remember that only business driving (not personal driving) counts for tax purposes. Whichever option you choose to pay employees, you must be sure that only business mileage and expenses, not personal expenses, are tracked.
You must have documentation of business purpose for both your business tax return and for employee taxes. That means every trip.
Paying Employees for Business Driving Expenses
No matter who owns the car—you or the employee—most companies pay employees for their business driving expenses. There is no federal law requiring employers to reimburse employees for driving costs, but some states, like California, do require employers to reimburse employees for mileage, so be sure to check your state before you decide on a driving reimbursement method.
For both options, you must have a specific type of IRS-approved plan, called an accountable plan, to make sure that the payments are not taxable to the employee and that you can deduct these business expenses. The requirements for having an accountable plan are that:
- The expenses must be for business driving only.
- The employee must give you complete and detailed expense reports within a reasonable time.
- The employee must return any excess payments within a reasonable time. An example of an excess reimbursement would be if you gave money to an employee before a trip and they didn’t spend all the money and didn’t return the excess.
The plan must be in writing and it must include all the details of how the plan works. You should date the plan and show that employees have received and read it.
The Two Options for Employee Driving Expenses
Both options use the IRS standard mileage rate as a basis for payment. This rate changes each year.
Giving Employees a Car Allowance
You can give employees a car allowance to pay for estimated driving expenses. The allowance must be based on, and not more than, the IRS standard mileage rate. For example, if you estimate that an employee will be driving 2,000 miles in the next month, you could give a mileage allowance of $1,160 for that month (2000 x the 2019 standard mileage rate of 58 cents). The employee must give you details on miles driven. If the employee drove more miles, you could add that to the next month. If they didn’t drive 2,000 miles in the month, the accountable plan rules require that the employee return the excess within 30 days after the expense.
You may also used an alternate fixed and variable rate (FAVR) for employee-owned cars. This rate combines the estimated cents-per-mile rate to cover variable costs plus a flat amount to cover the employee's fixed costs, like depreciation or lease payments. The IRS sets the maximum for this method each year.
You can reimburse employees directly for their business driving costs by requiring them to turn in driving expense reports. You can pay for actual costs or the IRS standard mileage rate. All reports must show detailed mileage and business purpose for each trip.
For the standard mileage rate, use the IRS mileage rate for the year and multiply it by the actual business miles for the employee for the month.
For actual costs, you’ll need receipts for all expenses, including gas, oil, tolls and parking, repairs, insurance, lease payments, and registration fees. You may have to prorate costs to include only the business use of the car. For example, if the employee drove the car 3,000 miles during the month and only had 2,000 miles of business use, expenses would have to be multiplied by ⅔ (0.66).
Which Is Better: Allowance or Reimbursement?
Every business is different, so it’s difficult to know which is a better plan for both the employees and your business. Here are some things to think about:
- Having employees submit reports and reimbursing them creates more paperwork, but it gives you more control over what is paid. You can limit the excess miles because employees are only paid for miles actually driven.
- Employees appreciate an allowance rather than having to wait to be reimbursed, but there is more possibility for expense fraud with this method, and you must be diligent in getting employees to give back excess payments.
Comparison of Payment Options for Tax Purposes
Actual expense reimbursement is not taxable to the employee if you follow your accountable plan and if employees return excess payments within a reasonable time. If the amount of the reimbursement is more than the IRS standard mileage rate for the year, the excess amount is taxable to the employee.
Under the 2017 tax law (Tax Cuts and Jobs Act), employees are no longer able to deduct unreimbursed expenses (business expenses paid by employees that your business doesn’t pay) on their personal tax returns.
A mileage allowance up to the federal mileage rate is not taxable to the employee if you follow your accountable plan. The employee must pay tax on any payments over the IRS standard mileage limit and on any excess payments they don’t return.
This article is a brief overview. The regulations are complicated and this is not tax or legal advice. Before you reimburse employees get help from your tax professional and attorney to set up an accountable plan and payment option.
IRS Publication 463: Travel, Gift, and Car Expenses. "Accountable Plans," Page 29. Accessed Sept. 17, 2019.
IRS Publication 535: Business Expenses. "Business Use of Your Car," Page 6. Accessed Sept. 17, 2019.
California Legislative Information. "Article 2. Obligations of Employer," Accessed Sept. 17, 2019.
IRS.gov, Publication 463: Travel, Gift, and Car Expenses. "Returning Excess Reimbursements," Accessed Sept. 17, 2019.
IRS Publication 463: Travel, Gift, and Car Expenses. "Per Diem and Car Allowances," Page 29. Accessed Sept. 17, 2019.
IRS.gov, Publication 463, Travel, Gift, and Car Expenses. "Fixed and Variable Rate," Accessed Sept. 17, 2019.
IRS Publication 463: Travel, Gift, and Car Expenses. "Adequate Accounting," Page 29. Accessed Sept. 17, 2019.
IRS Publication 463 Travel, Gift, and Car Expenses. "Table 6.1: Reporting Travel, Nonentertainment Meal, Gift, and Car Expenses and Reimbursements," Page 31. Accessed Sept. 17, 2019.
IRS Form 5307. Tax Reform Basics for Individuals and Families. "Miscellaneous itemized deductions suspended," Page 10. Accessed Sept. 17, 2019.