Figuring out the best way to pay employees for using their own cars for work can be tricky. You want to be fair, keep track of costs, and most importantly, follow IRS rules. This is where a Fixed and Variable Rate (FAVR) allowance comes in. It’s a smart way to reimburse employees that’s accurate, tax-free, and helps businesses manage expenses better.
Understanding How FAVR Works for Vehicle Costs
A FAVR program is a method that the IRS allows businesses to use to pay back employees for the costs of using their personal cars for work. Unlike a simple flat payment or a variable rate based just on miles driven, FAVR splits the costs into two parts:
- Fixed Costs: These are costs that don’t change much no matter how many miles you drive. Think of things like:
- Car payments or depreciation (how much the car loses value over time)
- Insurance
- Registration fees and taxes
- Variable Costs: These costs go up or down depending on how much you drive. These include:
- Gas (fuel)
- Oil changes and other regular maintenance
- Tires and other repairs
With a FAVR program, employees get a regular, fixed payment for ownership costs, and a variable payment based on the miles they actually drive for work, covering the operating costs. This makes the reimbursement much closer to what it really costs an employee to use their car for business.
Why Businesses Choose FAVR Over Other Systems
Many businesses choose to use a FAVR system because it offers several key benefits compared to older ways of reimbursing employees for car use.
One common method is just giving employees a flat car allowance each month. The problem with this? The IRS usually sees this as extra pay, like salary. This means the employee has to pay income taxes on it, and the business has to pay payroll taxes. It’s often not enough to cover the employee’s actual car costs after taxes are taken out, and it’s not tied to how much they actually drive for work.
Another very common method is the IRS Standard Mileage Rate. This is what most people think of for mileage reimbursement. The IRS sets a rate each year (like 67 cents per mile in 2024). Businesses pay employees this amount for every business mile driven. It’s simpler, and it’s usually tax-free if done correctly.
However, the Standard Mileage Rate is a national average. It doesn’t take into account that costs like insurance, gas, and even the value of a car can be very different depending on where the employee lives and what kind of car they drive. An employee living in a place with high gas prices and expensive insurance might not have their costs fully covered, even with the standard rate.
This is where FAVR stands out. Because it uses cost data for specific locations (often based on ZIP codes) and considers the type of standard car defined in the plan, it provides a reimbursement that is much more accurate and fair to the employee. It’s also designed to be completely tax-free for the employee and allows the business to accurately expense the cost, as long as all the IRS rules are followed.
