Auto expense allowance vs. expense reimbursements

Auto expense allowance vs. expense reimbursements

Many employers provide certain employees with an auto expense allowance via a fixed monthly or periodic payment. Unless the arrangement meets the “accountable plan” business connection, substantiation, refund of excess payments and reasonable period rules under Treasury Regulation 1.62-2, the allowance must be treated as taxable wages to the employee, subject to withholding and payroll taxes. It also most likely is treated as compensation under the company’s 401(k) plan and is subject to the appropriate withholding election and employer matching contributions.

The employee is able to deduct the appropriate auto expenses incurred on his or her individual return per Internal Revenue Code (IRC) section 162, subject to IRC section 274 substantiation rules. The deductions are treated as miscellaneous itemized deductions under IRC section 67, which limits the deduction to the extent all such deductions exceed 2% of a taxpayer’s adjusted gross income. Also, the amount is not deductible for Alternative Minimum Tax purposes. These rules severely limit the benefit of the deduction to the employee.

Generally it’s better for the employee if the employer adopts a plan that meets the requirements of Treasury Regulation 1.62-2. If so, the allowance is not taxable to the employee. The employee must forgo claiming deductions for the expenses incurred; however, that’s not a big deal as noted above. Complying with such rules is burdensome for both the employer and employee and may result in the employee paying some of the allowance back to the employer.

I have a simpler solution. Provide the employee an expense reimbursement in lieu of the allowance. The reimbursement can be capped at the amount of allowance. The employer will reimburse the applicable employee using the IRS mileage rate times the number of substantiated business miles up to a maximum desired amount.

For example, an employer was providing an employee a $300 monthly auto allowance and treating it as W-2 wages because it did not have an “accountable plan” that complied with Treasury Regulation 1.62-2. The employer changed the arrangement to provide the employee a monthly mileage reimbursement using the IRS mileage rate up to $300 per month. This reimbursement is not treated as W-2 wages. However, the employee cannot deduct the expenses relating to the business miles being reimbursed. Again, not a big deal.

The savings comes from excluding the $300 from wages for the employee and avoiding payroll taxes on the payment for the employer. It also may reduce certain compensation based insurance premiums and other retirement plan contributions.

The mileage substantiation can include calendars, dictation transcripts, or daily mileage logs. I use a daily log. It’s easy. I have not heard that any of my clients who use the reimbursement system have employees who don’t turn in records substantiating the miles needed to obtain the employer’s maximum reimbursement.

Weekend

I spent it here in the office learning how to blog.