A recent post on the Construction Financial Management Association (CFMA) website posed the question, “Are car allowances always taxable?” This is a question that many contractors, and taxpayers serving other industries, struggle with. While an in-depth analysis of the tax implications associated with auto allowances is beyond the scope of this article, hopefully this brief discussion will provide some general guidelines that will clarify the federal tax treatment.
The tax treatment of mileage allowances depends on whether they are provided under an accountable plan, the reimbursement exceeds the business standard mileage rate, and the business miles are timely substantiated.
To be considered an “accountable plan” the plan must (1) only reimburse expenses that are considered “ordinary and necessary” business expenses, (2) require the employee to substantiate the expenses to be reimbursed and (3) require that the employee return any allowance in excess of the amount substantiated.
The Internal Revenue Service has provided two simplified methods for employees to substantiate their auto allowance. The two substantiation methods are (1) the business standard mileage rate, and (2) the fixed and variable rate (FAVR) allowance. The business standard mileage rate is the most common method of reimbursing an employee's auto expenses, and therefore, will be the focus of this article.
Reimbursements based on the business standard mileage rate are in lieu of reimbursing employees for the actual fixed and operating costs (depreciation, maintenance, fuel, etc.) of using the automobile for business.
“Business miles substantiated” are miles for which the employee has properly substantiated that he or she incurred business-related transportation expenses. Proof generally is made by substantiating the dates, location, miles, and business purpose of the travel. “Miles not substantiated” are miles for which the employee has not properly substantiated these elements. In general, an employee is entitled to receive a mileage allowance only for substantiated business miles.
For federal income tax purposes, a mileage reimbursement paid under an accountable plan that relates solely to business miles substantiated, and does not exceed the business standard mileage rate, is:
- deductible by the employer as business expense,
- excluded from the employee's gross income,
- not reported as wages or other compensation on the employee's Form W-2,
- exempt compensation for federal income tax withholding (FITW), Social Security and Medicare (FICA), and federal unemployment (FUTA) tax purposes
Example #1: Reimbursement not exceeding the business standard mileage rate.
An employer uses an accountable plan that pays a mileage allowance of 50¢ per mile (less than the 2016 business standard mileage rate of 54¢ per mile). During 2016, an employee drives 100 miles on company business. The employee submits substantiation that proves the dates, location and business purpose of the 100 miles. As a result, the employer pays the employee a mileage allowance of $50 (100 × 50¢).
Based upon these facts, the employee has properly complied with the terms of the mileage allowance plan. Due to the fact that the $50 mileage allowance does not exceed the business standard mileage rate, the entire amount is (1) treated as paid under an accountable plan, (2) deductible by the employer as business transportation expense, (3) not reported as wages or other compensation on the employee's Form W-2, and (4) exempt from withholding and payment of employment taxes.
Example #2: Withholding and reporting on mileage allowances exceeding the business standard mileage rate.
If the employer's mileage allowance exceeds the business standard mileage rate for miles substantiated, the excess is (1) treated as made under a nonaccountable plan, (2) reported as wages on the employee's Form W-2, and (3) subject to withholding and payment of employment taxes.
Assume the same facts as example #1, except that the employer reimburses its employees for substantiated business miles at a rate of 64¢ per mile (10¢ more than the 2016 business standard mileage rate of 54¢ per mile).
Using 64¢ per mile, the employer reimburses the employee $64 (100 miles × 64¢) for those business miles. $54 (54¢ × 100 miles) of the mileage reimbursement payment is excluded from the employee’s gross income, not reported as wages or other compensation on Form W-2, and exempt from withholding and employment taxes. However, the $10 ($64 − $54) excess reimbursement is taxable income to the employee, and therefore, is included on the employee’s Form W-2 in boxes 1, 3 and 5.
Employers generally provide for the employee's portion of federal income tax withholding and FICA (including the additional 0.9% Medicare tax, if applicable) by either withholding from other cash wages paid to the employee, requiring the employee to remit to the company an amount equal to those taxes, or paying the taxes for the employee (the employee will recognize additional compensation if the employer pays the tax on behalf of the employee).
If you have any questions about the taxation of auto allowance plans in your construction company, please contact Schneider Downs.