If you don’t have a fleet of company vehicles and employees are driving their own vehicles on your business’s behalf – making deliveries, inspecting workplaces and gathering supplies – what are your obligations regarding fuel costs, maintenance and vehicle depreciation?
There are both legal requirements and business considerations to keep in mind when determining whether you need a mileage reimbursement policy and what it should look like. This guide explains the basics of mileage reimbursement and how to devise a policy that reimburses your employees fairly and efficiently.
Mileage reimbursement is when employers offer employees reimbursement for expenses associated with driving on behalf of the business. These expenses can include fuel costs, maintenance and vehicle depreciation.
Mileage reimbursement is typically set at a per-mile rate – usually below $1 per mile. Some companies prefer to set a monthly flat rate for reimbursement when employees are regularly using their own vehicles for company purposes. However, this approach can result in overpaying employees for mileage, which could incur additional taxes.
Managing a mileage reimbursement policy means understanding the minimum obligations under both federal and state laws, as well as how to establish an efficient rate that fairly reimburses employees without increasing their compensation and incurring payroll and income taxes for both the employer and employee.
There are two legal considerations to keep in mind when developing a mileage reimbursement policy: employment law and tax law.
On the federal level, there is no requirement for employers to reimburse employees for mileage when workers are using personal vehicles for company purposes. However, all employers are federally required to reimburse employees for any work-related expense to a point. When failure to reimburse employees – including for mileage and vehicle costs – causes an employee’s net pay to fall below the federal minimum, employers could be open to lawsuits and the legal penalties associated with failure to pay the minimum wage.
“On the employment law side, you are required to reimburse employees for expenses,” said Danielle Lackey, chief legal officer at Motus. “You want to make sure you’re reimbursing them enough to cover their expenses.”
Certain states – including California, Illinois and Massachusetts – do mandate that employers reimburse employees for mileage and vehicle expenses related to work.
Mileage reimbursement is tax-deductible for employers and independent contractors. Additionally, it is not considered income to an employee and therefore is nontaxable. [Read related article: Tax Deductions You Should Take – and Some Crazy Ones to Avoid]
However, if an employer reimburses an employee beyond the true expense of driving for work-related purposes, a portion of the reimbursement could be considered compensation and would be subject to taxation.
“On the tax side, if you’re reimbursing, it is considered tax-free both to employer and employee,” Lackey said. “If you pay more than the cost of reimbursement, it is considered compensation and is taxable.”
Some employers choose to offer flat rates for mileage reimbursement to ensure they are in compliance with any applicable employment law. However, this approach can backfire if flat rates are too high, translating into taxable income for the employee and incurring payroll taxes for the employer.
Each year, the IRS sets a mileage reimbursement rate. As of July 2022, the standard mileage rate is $0.625 per mile. For trips in 2022 that occurred from January to July, the rate was $0.585 per mile. Many employers reimburse employees at this rate, but the IRS amount is a national average based on the previous year’s data. It is more useful for tax deduction purposes than for setting a true reimbursement rate for your employees.
When establishing a mileage reimbursement policy, it’s important to consider that fuel costs vary significantly by geography.
“Computing geographic costs to each driver is important,” Lackey said. “Your own particular class of vehicle, the cost of driving that car where you live based on fuel costs and cost of depreciation … gets you closer to something that is accurate.”
“The IRS rate is the rate you can use to deduct [mileage as an independent contractor],” she added. “Some people use it as reimbursement rate, and there is a safe harbor concept around it, but it’s not efficient for most businesses and not geographically sensitive.”
Lackey recommended using a fixed and variable rate (FAVR) program to determine a suitable mileage reimbursement rate for your business. The FAVR method accounts for fixed costs such as insurance premiums, license and registration fees, taxes, and depreciation. It also includes any variable expense, such as fuel, oil, maintenance and tire wear. Each of these costs is estimated based on geographical data.
Mileage reimbursement sits at the intersection of employment law and tax law. Federally, you are required to reimburse employees for mileage if failure to do so would reduce their wages below minimum wage. Additional state considerations may apply as well.
There is no federal requirement under the Fair Labor Standards Act (FLSA) for employers to reimburse employees for mileage accrued while driving for work-related purposes. However, there may be state requirements for mileage reimbursements, so business owners should check state law and confer with legal counsel to determine whether they have an obligation to reimburse their employees.
Again, though, employers must reimburse employees for mileage if failure to do so would reduce their net wages below minimum wage. This rule applies to businesses of any size. Depending on state law, under-reimbursing employees could be illegal, regardless of their wages or salaries, and it is always illegal to pay employees less than minimum wage.
In the context of mileage reimbursement, Lackey added, “Minimum wage is calculated as net employee take-home pay after costs they may incur for necessary business.”
There are limits on what employers are required to reimburse, however. The standard under the law is “reasonably necessary expenses” to perform job duties, Lackey said. For example, if an employee chooses to drive a Ferrari to deliver pizzas, the employer is not on the hook for the immense fuel, maintenance and depreciation costs for that kind of vehicle. Mileage reimbursement rates could instead be based on a more commonly used car for the job description, like a four-door sedan.
“The business isn’t required to reimburse you for the cost of that specific car,” Lackey said, “but the reasonably necessary costs.”
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The current IRS mileage deduction rate as of July 2022 is $0.625 per mile. This means employers and independent contractors are legally allowed to deduct that amount from their taxes when reimbursing employees for mileage accrued while driving for company purposes.
This rate is up 6.5 cents from 2021, when the deduction rate was $0.56 cents per mile. The IRS uses a national average of data to determine its annual rates. For a more accurate depiction of local driving costs, consider using a FAVR program and working with a third party to develop a rate that reflects the true costs your drivers incur.
Establishing and managing a mileage reimbursement policy can be tricky, but there are a few steps you can take to make the process easier.
Geographic data is king. Understanding the typical driving costs for your region can help you determine a fair rate that will cover employee expenses as required by law without overcompensating staff and incurring additional taxes.
Tracking mileage and vehicle costs on a driver-by-driver basis gives you a more accurate picture of individual expenses. Reimbursing based on individual drivers, rather than extending a flat rate on a monthly basis, can help you manage reimbursement costs and avoid additional taxes.
Some software, like Motus’ mileage reimbursement application, can eliminate over-reporting of mileage by drivers and make documenting mileage reimbursement easy.
“Employers often ask employees to manually track miles … we found the number of miles tracked by auto-capture versus manual capture is 20% lower,” Lackey said. She added that “people are not necessarily lying or trying to cheat the system,” but often just rounding up to the nearest mile.
Using a GPS fleet management system is a great way to efficiently manage all aspects of your driving team, including tracking and reimbursing mileage. These tools provide real-time data on employees’ fuel usage, idle time and distance traveled to help you look for opportunities to reduce fuel costs and improve the overall efficiency of your fleet. Learn more in our overview of the best GPS fleet management software and systems.
Employees should clearly understand your reimbursement rate and policy, including when expenses will be reimbursed and to whom they should send expense reports. Software can automate some of the process, automatically sending mileage reports to supervisors for approval. Clearly state the payment method of reimbursement as well – for example, will it be added to an employee’s paycheck each cycle? Or will it be a separate deposit?
By using data to determine the optimal rate and leveraging software to track your drivers’ activities, you can establish an efficient and appropriate mileage reimbursement policy. This will keep you in compliance with legal requirements without hurting your company’s bottom line. Find out more labor laws you need to know for your business.
Jocelyn Pollock contributed to the writing and reporting in this article. Source interviews were conducted for a previous version of this article.