Fixed and Variable Rate (FAVR) Automobile Reimbursement Program – A Better Choice for Your Organization?

Are you a business or organization that has employees on the road? Maybe sales personnel are driving from town to town to meet with clients, businesses and organizations to promote business products. Maybe operations personnel are in the field managing a construction project or working with a business on a special project. In most of these instances, organizations are probably reimbursing the employee on a cents per mile program, or maybe they have a car allowance each month to be used for gas and car maintenance. There is also the possibility of having a vehicle fleet that is used by staff and managed by the business. In all of these possibilities, there are potential tax and expense consequences for both the employee and the business. This article will examine a fourth option, the Fixed and Variable Rate (FAVR) automobile reimbursement program and how this might be a better option for both businesses and employees.

What is FAVR?

In its simplest terms, a FAVR reimbursement is a tax-free car allowance for an organization’s mobile workforce. FAVR is an IRS-compliant program (IRS 2000-48) that lets companies reimburse mobile employees who use their personal vehicle for work. FAVR is a program that replaces company-owned fleets and taxable car allowances to reimburse employee-owned fleets. FAVR can also be used to replace car allowances and mileage reimbursement programs and lets employees drive their personal vehicle for work, tax free.

Why Consider a FAVR Program?

There are various advantages to the use of a FAVR program to both the business and the employee. Below is a summary of some of those advantages.

• Eliminates the need for a company-owned vehicle fleet.
  • Eliminates insurance risk of company vehicles and imparts the insurance risk back to the employee.
  • Eliminates high operating cost of routine maintenance and other repairs and shares the vehicle expense of the personal vehicle with the employee.
  • Eliminates the administrative burden of managing the vehicle fleet.

One may be saying, vehicle fleets do have tax advantages, as the expense of the fleet is tax deductible. However, the cost incurred for the fleet and cash management of maintaining the fleet could very well outpace the tax savings a business might get from having a fleet of vehicles.

• Eliminates standard car allowances that can have tax consequences to both the business and the employee.
  • Flat car allowances could be taxed if reimbursement is more than the actual automobile expenses for the month.
  • Car allowances can be taxed at the company payroll tax rate (Social Security and Medicare – 7.65%) as well as at the employee’s income tax rate.
  • Administrative burden rests with the employee to track and log mileage to compare to the car allowance.
  • Example: Allowance per month is $600. Business miles driven for the month is 500 miles. IRS standard rate reimbursement would be $335 (500 miles at $0.67). Average reimbursement per mile would be $1.20 ($600 allowance divided by 500 miles). Delta of $0.53/mile ($1.20 less $0.67) multiplied by business miles driven of 500 or $265 would be considered taxable income to the employee and require withholding tax on the part of the company.
• Eliminates reimbursement of cents per mile.
  • The business cents per mile does not take into account the life, maintenance, and other wear and tear of travel on an employee vehicle.
    • Example: A Ford Escape has an annual cost of ownership (insurance, maintenance, repairs, taxes/fees, depreciation, and fuel) of $6,000 annually. If the car is driven 15,000 miles for business, the employee has been paid $10,050 for a reimbursement surplus after cost of $4,050.
  • For an employee, cents per mile could underpay certain employees for use of their car. This could be the case for low-mileage employees who are, nonetheless, required to own and operate a vehicle on behalf of the business.
    • Example: A Ford Escape has an annual cost of ownership (insurance, maintenance, repairs, taxes/fees, depreciation, and fuel) of $6,000 annually. If the car is driven 5,000 miles for business, the employee has been paid $3,350 for a reimbursement deficit after cost of $2,650.

How Does FAVR Work?

FAVR is a combination of both a fixed and variable rate reimbursement program. To better understand how the program works, let’s define what is considered a fixed vehicle expense and a variable rate vehicle expense.

Fixed Expense

• Depreciation or lease payments
• Insurance premiums
• License and registration fees
• Personal property taxes

Variable Rate Expense

• Fuel prices
• Oil changes
• Tires
• Routine maintenance
• Repairs

Basically, how a FAVR vehicle reimbursement program works is the business and the employee calculate the above expenses and add them together into a car allowance. Because this is considered a more precise calculation of expense, the allowance is then considered tax-free to the employee and the business. In order to perform this calculation market research may be required.

Calculating Fixed Costs

Fixed costs can be calculated by knowing the depreciation schedule, i.e. how much the vehicle type depreciates per year, and then dividing that by 12 for a monthly calculation. One also needs to know their insurance per month, annual licensing and registration fees, and any personal property taxes they pay on the vehicle. Add up all the fixed costs then that is the fixed rate reimbursement.

Calculating Variable Costs

Calculate the variable portion by adding up all the variable expenses per mile. For example, an oil change costs $50 and on is needed every 5,000 miles, so it costs one cent per mile. If gas costs $3 per gallon, and the car get 30 miles per gallon, gas costs 10 cents per mile. New tires are $800, and the current tires are rated to last 40,000 miles, then the tires cost two cents per mile. All cost should be calculated based on location of the employee and business. Market data research by zip code may be necessary to determine these costs.

Other Considerations in the Calculation

Vehicle Types

• Reimbursement is not based on actual vehicle driven but vehicle type.
• Vehicle deemed reasonable for the job – program standard vehicle.
• Employees don’t actually have to own the vehicle. Mobile employees just have to have a vehicle that, when new, cost 90% of the price of the program standard vehicle; so, if the program standard vehicle type costs $50,000, an employee needs to have a vehicle that costs at least $45,000.
• Once a program standard vehicle has been established, then the organization knows the miles per gallon, the MSRP, and all the other expenses related to owning a certain vehicle. And, once one has all of those expenses, they are ready to pursue an actual costs accounting method to come up with their FAVR rates.

Zip Codes and FAVR

• Variable costs are calculated based on local component.
• Example: If the driver is in Naples, Florida, they can calculate their reimbursement based on that locale. If they’re in Billings, Montana, fuel data can be pulled from the location, along with insurance data and other related cost, to give the drivers a local specific reimbursement plan.

Sample Calculation

An FAVR program can provide the business and the employee with a number of advantages from internal reduced cost for the business to a tax-free reimbursement program for the employee. FAVR can be another option to consider for those businesses that have personnel on the road regularly or require the employee to have a car to travel as needed.

To learn more about this program and how it might benefit your business and employees, please contact David Blain, CPA, CVA, Partner and Director of Entrepreneurial Accounting Solutions (EAS).

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