An employer provides car allowances to cover the lease or purchase of a vehicle for business purposes or the maintenance of an employee’s current vehicle when used for business. Allowances can be paid monthly, quarterly, or yearly, and the car allowance amount will typically depend on the amount you’re expected to drive, the type of car, and current gas prices.
If your organization provides a car allowance, it may be unclear if the allowance is part of your taxable income or if the tax is the company’s responsibility. Learning the tax laws surrounding car allowances, including possible credits and deductions, can help you be prepared during tax time and ensure you aren’t over or underpaying the IRS.
Is a Car Allowance Taxable Income?
The IRS generally treats a car allowance as taxable income because it is considered compensation and is taxed along with your regular income at the federal and state levels. Employers and employees must also pay FICA and Medicare taxes on the allowance.
Example: Thomas is a pharmaceutical sales representative in Florida who receives a $600 a month car allowance, which is federally taxed at 22%, and his FICA contribution of 7.65% is also deducted. This leaves him with a usable car allowance of $422.10. He has no state income tax because he is a resident of Florida.
Is a Car Allowance Taxable in 2022?
In 2022, a set monthly car allowance to pay for a lease, maintenance, or gas is taxable, but the mileage reimbursement is not as long as it stays below the requirements of the IRS.
Is a Car Allowance Taxable in 2021?
Just like in 2022, for car allowances to be nontaxable, they must stay below the IRS per mile limit. Anything paid over that amount or set payments made periodically for a lease, gas, or maintenance is taxable.
Is a Car Allowance Taxable in 2020?
A car allowance is nontaxable on an accountable plan, meaning there is a receipt for the use of the vehicle in the form of mileage trackers. Nonaccountable plans, such as regular payments to employees without mileage trackers or maintenance receipts, are subject to taxation.
When is a Car Allowance Taxable?
Because car allowances come in many types, some forms are taxable while others are not. Car allowances paid in a set amount in periodic intervals are taxable. While an allowance that is tracked with the dates, times, or receipts and does not exceed the mileage price set by the IRS is nontaxable.
Taxable Example: Alan is given a car allowance of $1,000 per month to cover the lease, maintenance, and gas for a vehicle to be used for work purposes. Alan is not required to track mileage, maintenance costs, or fees. The additional $1,000 per month is taxed along with the rest of his expected salary.
Nontaxable Example: Sarah uses her personal vehicle to travel to clients’ homes. She uses the standard IRS mileage rate of $0.625 for her 1,000 miles driven in 2022. Sarah will receive a reimbursement from her company for those 1,000 miles, and they will not be taxed.
5 Car Allowance Types and Their Tax Implications
Car allowances can vary based on the agreement between the employee and employer for what is best for each situation. Some people only need the allowance for fuel, some use the standard mileage rate, and others use the allowance to purchase or lease a car. It’s important to know which option you need and how to choose the right plan for you.
1. Car Allowance with a Fuel Card or Fuel Reimbursement
A fuel card or fuel reimbursement is precisely as it sounds, money provided to cover the cost of fuel for business purposes. This type of allowance can be hard to manage because of fluctuating gas prices, leading to overspending or underspending of the funds.
What is the tax liability of a car allowance with a fuel card or fuel reimbursement?
Fuel cards are taxed unless the employee can prove that the fuel was used for business purposes.
Employer Tax Liability
The tax liability of a fuel card for the employer is that it is considered income to the employee. The amount paid can be deducted as a standard payroll deduction.
Employee Tax Liability
The employee’s tax liability depends on the proper tracking of business use of the vehicle. It can be deducted if the employee can prove that the gas was used for business. All other uses are taxable along with standard income.
2. Car Allowance With Mileage Reimbursement
A car allowance with mileage reimbursement is when an employee tracks the mileage used in their personal vehicle and submits the mileage receipts and the end of a set period. The company then pays the employee the amount to offset her mileage costs. Due to the Tax Cuts and Jobs Act (TCJA), a tax reform that aims to help businesses and create jobs, this won’t be an option until 2026.
What is the tax liability of a car allowance with mileage reimbursement?
Mileage reimbursement is not taxable as long as it is within the standard the IRS allows, which is 62.5 cents per mile for 2022.
Employer Tax Liability
An employer’s tax liability for car allowance with mileage reimbursement is to consider anything past the standard mileage rate as taxable income.
Employee Tax Liability
An employee is responsible for tracking their business miles and using the standard mileage rate to calculate a deduction on their taxes.
3. Fixed and Variable Rate Car Allowance (FAVR)
FAVR car allowance plans allow employers to choose if they will pay a fixed rate or vary the payment for an employee’s business expenses with an employee’s vehicle. This plan is best for companies that employ across different states where they might see significant differences in gas prices.
What is the tax liability of a car allowance with a fixed and variable rate?
A fixed rate car allowance is taxable at the federal and state levels in line with the standard income. In a fully accountable program where the employee tracks all mileage, maintenance, and fees, there is no tax liability for either the employer or the employee.
Employer Tax Liability
If the employer pays a fixed rate for a car allowance, the IRS sees it as ordinary income, and the employer must pay FICA and Medicare taxes on the allowance. The employer must also ensure the post-tax amount can adequately cover the cost of the vehicle purchase or maintenance after a 30-40% reduction for taxes.
Employee Tax Liability
Employees must claim the allowance as part of their standard income for a fixed rate car allowance. There is no tax liability for a variable rate in which the employee keeps proper records and implements the plan correctly.
4. Standard Car Allowance
A standard car allowance is when an employer provides money to an employee to purchase or lease a vehicle or for maintenance and gas for the vehicle. It may also be used for gas or maintenance for a personal vehicle for work purposes. Standard allowances are a set amount paid in regular intervals regardless of mileage or usage trackers.
What is the tax liability of a standard car allowance program?
A standard car allowance is a taxable income at the state and federal levels.
Employer Tax Liability
The employer should withhold taxes from a car allowance in correlation with FICA and medicare. It’s also essential to set the correct amount to cover all vehicle expenses, even after withholding taxes. The employer can also deduct the payments along with standard payroll tax deductions.
Employee Tax Liability
Employees receiving a standard car allowance should also expect to be taxed based on FICA and Medicare deductions.
5. Car Allowance With Mileage Substantiation
A car allowance with mileage substantiation is a mixture of a standard car allowance and a mileage reimbursement. An employer will create a preset car allowance to be paid to the employee each month.
The amount is substantiated by the monthly business mileage multiplied by the IRS mileage rate. As long as the employee’s mileage time multiplied by the IRS standard rate does not exceed the car allowance, the mileage is substantiated and will not be taxed. Due to TCJA, this is not an option until 2026.
What is the tax liability of a car allowance with mileage substantiation?
As long as the mileage is substantiated and does not go above the IRS standard rate, it is not taxable. TCJA makes this impossible until 2026.
Employer Tax Liability
An employer’s tax liability for car allowance with mileage reimbursement is to consider anything past the standard mileage rate as taxable income. And deduct standard payroll deductions.
Employee Tax Liability
An employee is responsible for tracking their business miles and using the standard mileage rate to calculate a deduction on their taxes.
How Does the IRS Tax Car Allowances?
The IRS taxes standard car allowances as standard W-2 income since it is considered nonaccountable.
Nonaccountable Vehicle Reimbursements
Nonaccountable vehicle reimbursements, such as set amounts paid to employees in regular intervals, are seen as regular income and are, therefore, for vehicles taxed as standard income.
Employer Tax Liability
The employer is required to withhold federal taxes just like regular wages.
Employee Tax Liability
The employee must treat it as income and expect it to be taxed by the federal government.
Accountable Vehicle Reimbursements
Accountable vehicle reimbursements, such as mileage reimbursements, fall within the IRS guidelines of what is acceptable for business expenses. Employees must keep accurate records to provide evidence of business use for employers to show allowable reimbursements.
Employer Tax Liability
The allowance amount should still have taxes withheld by the employer if the allowance is not entirely used.
Employee Tax Liability
An employee should substantiate their vehicle use for business purposes and write an amount based on the IRS standard mileage rate as a deduction.
How Do the States Tax Car Allowances?
States tax car allowances the same way as the IRS; they consider it additional income on a W-2. Since it is additional income on a W-2, it is taxed at the same rate as regular income.
Is a Car Allowance Taxable in California?
Yes, car allowance is taxable in California unless the business uses a substantiation process such as FAVR.
Employer Tax Liability in California
The employer is expected to withhold taxes from the car allowance as if it were income.
Employee Tax Liability in California
The employee only needs to worry about liability if they file mileage deductions based on business usage.
Is a Car Allowance Taxable in Florida?
Since there is no state income tax, Florida will not tax a car allowance. Federal, social security, and medicare taxes will still apply.
Employer Tax Liability in Florida
The employer must withhold federal, social security, and medicare taxes from any car allowance payment.
Employee Tax Liability in Florida
As an employee, you should deduct any expenses for business uses in accordance with the IRS standard mileage rate.
Is a Car Allowance Taxable in Texas?
Like Florida, Texas has no individual income tax, so residents will not pay state taxes on car allowance, but they are still expected to pay federal income taxes.
Employer Tax Liability in Texas
While the state of Texas will not tax the income, the federal government still will and requires proper documentation of the income on a W-2.
Employee Tax Liability in Texas
The income should only be documented if you plan on claiming a deduction based on the business usage of a vehicle.
Is a Car Allowance Taxable in Pennsylvania?
Car allowance is taxable in Pennsylvania and is considered additional income to be reported on a W-2.
Employer Tax Liability in Pennsylvania
Just as you would fill out the W-2 for the IRS, the same must be done for state taxes.
Employee Tax Liability in Pennsylvania
There is not much difference between states for employees as they only need to worry if they are claiming deductions for business travel.
Is a Car Allowance Taxable for Miscellaneous Driving?
Yes, car allowance is taxable if used for miscellaneous driving. Because standard car allowance is taxable no matter the purpose, the IRS does not view miscellaneous driving differently from business driving.
For allowances based on mileage or tracking, miscellaneous driving is still taxable because the non-taxable mileage reimbursement can only be used for business purposes.
How Do I Report My Car Allowance Income on My W-2?
Reporting income on your W-2 depends on the type of car allowance you pay your employees. Nonaccountable plans, such as a set monthly payment, are simple to report and done the same way as standard payroll while accountable plans will vary depending on how you distribute the income and report your deduction.
Nonaccountable plans are the simplest to report but are fully taxed as income. The entire amount will be recorded in box 1 on the W-2 form, and the entire amount will be recorded and taxed as income.
There are two cases where no amounts will be reported on the W-2:
- An actual expense reimbursement where adequate accounting has been done and excess money returned.
- A per diem or mileage allowance up to the federal rate where adequate accounting has been done and excess money returned.
Both of these scenarios will not require any amount reported on a W-2.
In terms of actual expense reimbursement, where the employee does not return the money, any excess money is reported in box 1 of the W-2 form.
Similarly, per diem or mileage allowance where the excess funds are not returned requires the excess amount to be reported in box 1 of the W-2, and then, under code L in box 12, the amount up to the federal rate is reported.
Because of the Tax Cut and Jobs Act, any mileage reimbursements for the business use of your car can no longer be reported. Prior to 2018, you were able to report vehicle expenses on a Schedule A (Form 1040) under “job expenses and certain miscellaneous deductions.”
Car Allowance vs. Mileage Reimbursement: Which is Cheaper on Tax?
Car allowance is a stipend paid to an employee for vehicle use. On the other hand, mileage reimbursement is a per-mile rate multiplied by a set amount according to an employee’s work contract. Car allowances are almost always taxable, while mileage reimbursements, if equal to or less than the IRS standard rate of 62.5 cents per mile, are tax-free.
At first look, mileage reimbursement is cheaper on tax because unless paid above the IRS standard rate, that portion of the income will not be taxed. The mileage reimbursement doesn’t account for maintenance, registration, or increase in gas prices, and it can be challenging to determine rates.
FAQs
Here are the answers to some common questions about taxability car allowances.
A car allowance is considered taxable income for clergy, but some deductions are allowed using Form 2106.
Yes, standard car allowance goes on a W-2 if it is a nonaccountable plan.
Yes, a car allowance is a fringe benefit as it is pay for performing business services.
Yes, a car allowance can be written off by a company as a business expense because it is seen as standard payroll for employees.
Offering a car allowance instead of an increase in salary helps the company keep salary-related costs down, such as life insurance and disability insurance.
A company car is a vehicle bought and paid for by the company for you to use, and a car allowance is money given to you to buy, lease, or maintain a vehicle you use for business.
A company car counts as income if used for purposes other than business.