How Does a Car Allowance Work?
When employees need to use their own vehicle for business purposes, companies may provide them with what is known as a car allowance. But what exactly is a car allowance?
A car allowance is a predetermined amount of money that an employer provides, in addition to their regular salary, as a contribution toward the costs of using their personal vehicle for business-related driving. Companies may implement a car allowance as an alternative to providing company cars to certain employees.
There are a few key car allowance benefits, and this is why companies opt for car allowance over company cars. It can be more cost-effective, it avoids the administrative burden of acquiring and maintaining a fleet of company vehicles, and it gives employees more flexibility and freedom with their choice of vehicle.
Types of Car Allowances:
There are different structures that companies can use when providing car allowance compensation. The main types include:
Fixed Car Allowance
A set amount is paid periodically, regardless of how many business miles were driven. This is simple but may overcompensate low mileage drivers.
Variable Car Allowance
The allowance amount varies based on the number of business miles driven each period. This aims to align compensation with actual driving needs.
Reimbursement-based Car Allowance
Employees will keep note of their usage in a mileage log, these are submitted and then reimbursed based on a per-mile rate for business miles driven.
What Influences Car Allowance Amounts?
The amount provided for a car allowance can vary significantly based on a few key factors. One major consideration is the employee's job role and requirements. Employees who are required to travel frequently for their job duties, such as sales reps regularly visiting clients, may receive a higher allowance than those with minimal driving needs.
Location and regional costs can also have an impact on the allowance level. Employees based in areas with higher overall vehicle operating costs may justify a bigger allowance.
Tax Implications of Car Allowances
Before implementing a car allowance program, companies need to consider a few important factors:
Tax Treatment of Car Allowances:
Recordkeeping Requirements:
Employees and employers are required to maintain mileage logs. This can get complicated and if you forget to note down the mileage then you are at a loss.
Reporting Car Allowances on Tax Returns:
Employees may be able to deduct qualified business expenses more than their car allowance on their tax returns.
Car Allowance vs Company Car
How does a car allowance compare to being provided a company car for business use? There are some key pros and cons for each option.
Car Allowance Benefits:
Employees can choose their own vehicle, one that suits their needs and preferences. There are fewer restrictions, so they can freely use their vehicle for both work and personal use.
Car Allowance Restrictions:
Employees are responsible for all maintenance, insurance, and fuel costs with their personal vehicles. Employees may be required to keep detailed records and report their business-related mileage and expenses for tax purposes, adding an administrative burden.
Company Car Benefits:
Having a company car allowance can eliminate the hassles and costs of owning your own vehicle, saving employees from many recurring costs.
Company Car Restrictions:
Employees have limited choice in the vehicle they are assigned, and this may not align with their personal preferences, ethics or needs. There are also restrictions on personal use, with guidelines on mileage and usage.
A car allowance can be a good solution for companies who are looking to cover employees' business driving needs cost-effectively while providing flexibility. However, companies need to be careful, and to account for tax and recordkeeping.
Make sure to check out our previous blog post for a more in-depth look at car allowance vs company car, which is the best option?