In many careers, business travel is important and is often a requirement. To ease the burden, some organizations provide employees with company vehicles (which can be an expensive perk), or reimburse a set amount for every mile employees drive in their own vehicles. The latter is called mileage reimbursement, and it is mutually beneficial for both employees and employers.
It provides fair compensation to the employees, and tax benefits to the employers. However, the rules of mileage reimbursement are slightly complicated compared to other types of expense reimbursements, and every country has its own rules that dictate the maximum reimbursement rate per mile or kilometer. For this reason, it’s important for employees to understand the basics of mileage reimbursement and the requirements for claiming reimbursement accurately. Finance teams must know exactly how to track mileage expenses and promptly reimburse their employees.
What is mileage reimbursement?
Mileage reimbursement refers to the amount paid by employers to employees for the costs associated with use of their personal vehicle(s) for business purposes. Employees are reimbursed based on a rate set by official bodies, like the IRS (in the USA) and the HMRC (in the UK).
What does mileage reimbursement cover?
Mileage reimbursement covers the cost of fuel, gas, oil, tires, maintenance and repairs, insurance, and vehicle depreciation. According to the IRS, a mileage expense should be ordinary (it is common or accepted in the industry) and necessary (it is helpful or appropriate to the business), meaning personal detours of any sort are excluded. Let’s say an employee uses their car to attend a workshop that is 60 miles away from your office. After the session, they make a quick stop at a cafe that is 10 miles further to meet their friend. On returning to the office, having driven 140 miles, they would only be reimbursed for the 120 business-related miles.
Here are some examples of valid reimbursement claims:
Driving to the airport or train station for business travel
Travel to a temporary job site
Trips to the bank or stores for business purposes/purchases
Driving to meet clients off-site or attend meetings, trade shows, and seminars
It’s important to note that not all employees who use their personal vehicles for business purposes are eligible for reimbursement. Eligibility requirements, covered expenses, and payment terms depend on the employer and the organization’s reimbursement policy.
Here are some possible use cases to understand this better:
A. If the employee owns or leases the vehicle
When the vehicle is used for business, the employer should reimburse the costs of owning and operating the vehicle as discussed above.
B. If the employee is self-employed on the side
The employee should maintain two separate records of business mileage—one as an employee (that is reimbursed by the employer), and another as a self-employed individual.
C. If an independent contractor or a consultant owns or leases the vehicle
Contractors and consultants (for instance: contractors who work for food delivery and ride-share companies) are typically not reimbursed by their employers for mileage.
D. If the vehicle is provided by the employer
Depending on the arrangement, the employee might still be reimbursed for the expenses of driving and operating the car.
Why is employee mileage reimbursement important?
While there is no federal requirement for US employers to reimburse employees using personal vehicles for work, some companies are subject to state requirements. Ironically, the federal law mandates employers to reimburse their employees for all business-related expenses, and failure to do so might cause the employee’s net pay to fall below the federal minimum. In this event, employers face lawsuits and associated penalties for not paying the minimum wage. For this reason, it’s advisable for firms to check their state laws and seek legal counsel before drafting a reimbursement policy for mileage.
There are multiple ways to reimburse your employees for using their personal vehicles, and they all use the IRS standard mileage rate as a basis for payment. Before diving deep into the different reimbursement methods, here’s everything you need to know about the IRS standard mileage rate.
IRS standard mileage rate
In the US, the standard mileage rate is set by the Internal Revenue Service (IRS), and in other countries, by national revenue agencies. The rate varies on an annual basis (The IRS standard mileage rate for the year 2022 is 58.5 cents), and acts as a tax deduction benchmark for employers and independent contractors. Simply put, the standard rate is the amount that the IRS permits for mileage deductions on tax returns. Any reimbursement amount exceeding the standard rate must be reported as income and taxed. While firms are free to set their own reimbursement rates, most choose to follow the standard mileage rate.
Employee mileage reimbursement methods
You can give your employees an upfront, monthly allowance to cover their vehicle-related expenses. For example, you could give a mileage allowance of $585, assuming the employee will travel 1,000 miles in the upcoming month (1,000 x IRS standard mileage rate of 58.5 cents for the year 2022). At the end of the month, the employee must submit their mileage log, and return any excess allowance within 120 days after the expense was paid or incurred. If they’ve driven more than 1,000 miles, you can add it to the next month’s allowance. Some companies pay a fixed monthly car allowance along with the mileage allowance. In this case, the car allowance is taxable but the mileage allowance is not.
All funds spent on operating the vehicle are added up and multiplied by the percentage of business use. Employers can reimburse their employees directly for driving costs once they turn in their expense reports. Expense reports should include a detailed mileage log, the purpose of each trip, and proof of payment (such as receipts).
You must pay the actual costs incurred and tracked by employees during business-related travel. This may include gas, parking, and tolls. It will also include the lease payments, auto insurance, maintenance, and depreciation charges.
If an employee is paid at a rate higher than the IRS standard rate, the excess will be taxed. If they receive a lower rate, they can claim mileage deductions on their annual tax return to compensate for the difference.
The standard mileage method
Employers pay a flat rate per mile driven. This is a cents-per-mile rate, which eliminates the need to calculate the value of each trip or the actual amount the employee has spent. Employers can simply multiply the standard mileage rate by the number of miles driven over a specific period, and the result is the mileage reimbursement. So, if the employee drives 1,000 miles that month, they will be reimbursed $585.
FAVR (Fixed and Variable Rate)
A common alternative to the standard mileage method, FAVR involves reimbursing employees with a combination of the estimated cents-per-mile rate to cover variable costs, and a flat amount to cover fixed costs. Examples of variable costs include gas, oil, maintenance, and repairs. Fixed costs can include the lease, license and registration fees, depreciation, and insurance. You still have to refer to the IRS’ standard mileage rate, and, as usual, any excess reimbursement will be taxed as income.
Tracking mileage reimbursement
To receive mileage reimbursement, you have to keep track of the miles you drive. In the US, the IRS has made it mandatory to maintain an error-free mileage log with details on the time and date of each trip, a brief description of the purpose of the trip, the destination of each trip, and the total distance covered.
Since the IRS does not have any hard and fast rules, different organizations have different methods for tracking mileage. While some record odometer readings manually, and later share the data with their finance teams, most prefer to invest in a mileage tracking application or expense management system with a built-in feature to track mileage
A top-notch expense management solution will automatically calculate the mileage reimbursement rate according to your organization’s expense policy and the employee’s jurisdiction. Here are some popular ways these apps track mileage:
Enter the total distance travelled for your mileage expenses to be automatically calculated based on the pre-set rate per mile or kilometer.
Enter the start and end locations of the trip on the map for the expense claim to be automatically generated.
Enter the start and end readings of the vehicle’s odometer.
Tap start and stop within a mobile application when you commence and end a trip to auto-calculate mileage expenses.
Once the mileage expenses have been recorded and submitted, the approver (line manager or department head) can validate them and forward the report to the finance team for verification and reimbursement. Using expense management software, you can customize your organization’s approval workflows and designate the right line managers or team leads to sign off on reimbursement. You can even establish an audit trail to facilitate transparent record keeping.
Here’s your takeaway!
Inflated mileage claims are among the most common types of expense fraud. What starts with a few cents per mile can add up to a significant amount at the end of the year. This is why mileage claims are often the cause of IRS audits. To streamline the reimbursement process, from recording mileage to mitigating expense fraud, to speeding up reimbursement, many companies are moving to expense management software, like Zoho Expense. Zoho Expense simplifies the process of establishing an IRS-compliant mileage reimbursement system, prepares you to tackle IRS audits, and helps you stay on top of your mileage expenses.