January 2008 - Cover Story
Why Reimbursement Doesn't Work
By Mike Antich
Six Tax Consequences of Driver Reimbursement
1. Taxable Income. If a company provides an employee a $500 monthly car allowance, the employee will have approximately $200 in tax liabilities for federal and state income tax, based on a 40-percent combined tax bracket. If the employee needs to spend $200 on taxes, in reality he or she will have only $300 to spend for the car, not $500.
2. Two-Percent Adjusted Gross Income Threshold. Theoretically, employees can deduct all business-related expenses and business mileage on their federal and state personal income tax returns and get the $200 back.
However, this is not always the case. On an individual tax return, an employee must itemize deductions; not everyone does. If deductions are not itemized, a driver is not eligible for any business-related tax deductions for the use of their personal vehicle.
If a driver does itemize deductions, then a 2 percent of adjusted gross income floor has to be met before expenses for the business-related use of a personal vehicle can be deducted.
For example, if an employee is making $100,000, the first $2,000 is not deductible. The adjusted gross income floor restricts an employee’s ability to obtain a tax benefit on business-related vehicle expenses.
This rule only applies to individuals, not companies. In addition, if a driver is married and files a joint income tax with a combined annual income exceeding $145,950, then there is a phase-out of up to 80 percent of the allowable itemized deductions beyond the 2-percent threshold.
3. Social Security (FICA) Taxes. Using the example of a $500 per month car allowance, this money is subject to FICA taxes, which are shared by the employer and employee. FICA taxes cannot be reduced by itemized deductions for the business use of a personal vehicle.
4. Interest Payments are Not Tax Deductible. If the employee finances a personal vehicle, the interest expense is not tax deductible. The IRS ruled years ago that personal interest payments are not deductible by individuals even if used to finance a personal vehicle required for their jobs. However, if a business finances a company vehicle, the interest expense is deductible.
5. Increased Risk of IRS Audit. The audit burden falls on the reimbursed employee for substantiation of all business expenses. Employees may not realize that mileage expenses and other reimbursed costs for business use of a personal vehicle are subject to audit by the IRS, and drivers are notorious for not keeping good records.
6. Exaggerated Business Mileage. Employees will attempt to maximize their reimbursement for mileage and vehicle expenses when they feel they are not being adequately reimbursed. One common way is to exaggerate business mileage.
When a company switches from a reimbursement program to a company-provided car program, the reported business mileage goes down by an average of 30 percent. It is not that employees drive less; it is that the business miles no longer generate reimbursement monies, so employees are reporting actual miles.
This shows that when a company switches to a driver reimbursement program it can expect a 30-percent exaggeration of business miles driven.
Counterpoint: Top Reasons for Reimbursement
There are circumstances where it is preferable to have employees provide their own transportation, and be reimbursed by the employer. These include:
- Temporary or intermittent requirement to drive.
- Low-mileage drivers (fewer than 12,000 miles per year).
- Lack of infrastructure to support an employer-provided pool.
- Strong employee preference may dictate the use of a reimbursement program as employees may wish to drive a specific vehicle for comfort or image reasons that are simply not acceptable for purchase as a fleet vehicle.
- The organization has limited funds available for purchase and does not want to lease vehicles.
- Public perception may prevent an organization from allowing employees to commute in their company-provided vehicles.
- Parking space or overnight security restrictions may prevent overnight and partial day storage of the employer’s vehicles. In this case, the employer may opt to eliminate its fleet vehicles and reimburse employees for the business use of their vehicles.