Offering a Car Allowance Plus Mileage Reimbursement
Structure a compliant vehicle reimbursement program that combines a fixed allowance with mileage, ensuring you correctly manage employee tax consequences.
Employers often provide compensation for the business use of a personal vehicle through two common methods: a car allowance or a mileage reimbursement. A car allowance is a fixed, regular amount paid to an employee to cover the costs of owning and operating their vehicle. A mileage reimbursement is a variable payment based on the number of business miles driven, calculated at a specific rate per mile. It is possible to combine them into a single program that offers the predictability of an allowance with the precision of a mileage-based payment.
Understanding Accountable vs. Non-Accountable Plans
The tax treatment of any employee reimbursement is governed by Internal Revenue Service (IRS) rules that classify payment structures as either accountable or non-accountable plans. An accountable plan is a reimbursement arrangement that meets three tests. The expenses must have a business connection, the employee must substantiate these expenses to the employer in a timely manner, and the employee must return any reimbursement in excess of the substantiated expenses.
Payments made under an accountable plan are not considered income and are not subject to income or employment taxes. A non-accountable plan is any arrangement that fails to meet one or more of these tests. For example, a car allowance provided without requiring proof of business use is non-accountable. All payments under a non-accountable plan are considered taxable wages and are subject to federal and state income taxes, as well as FICA taxes.
The goal of a hybrid program is to leverage the rules of an accountable plan to provide a non-taxable benefit to the employee. This ensures the full value of the reimbursement goes towards covering vehicle expenses rather than being partially lost to taxes.
Structuring a Compliant Hybrid Program
Combining a car allowance with a mileage reimbursement requires a specific structure to comply with IRS accountable plan rules, known as an “offset method.” Under this arrangement, the fixed car allowance is treated as an advance against future substantiated business mileage. The program reconciles the allowance with the actual business use of the vehicle, ensuring that only the portion for documented business travel remains non-taxable.
The process begins with the employer paying a recurring, fixed allowance. Throughout the payment period, the employee tracks their business mileage and submits a log to the employer at the end of the period. The employer then calculates the total non-taxable reimbursement by multiplying the business miles by an IRS-approved rate, such as the 2025 standard rate of 70 cents per mile. This calculated mileage value is then used to substantiate, or “offset,” the allowance that was advanced.
If the substantiated mileage reimbursement is less than the allowance paid, the excess amount is considered unsubstantiated and must be treated as taxable income. This amount is added to the employee’s wages and reported on their Form W-2.
If the calculated mileage reimbursement is greater than the allowance, the entire allowance is non-taxable. The employer may also choose to pay the employee the difference as an additional tax-free reimbursement, though this is not a requirement.
Recordkeeping and Substantiation Requirements
To satisfy accountable plan requirements, employees must maintain records to substantiate their business vehicle use. The IRS requires that this documentation, often a mileage log, be created in a timely manner by recording details at or near the time of travel. Creating a log from memory at the end of a month or year does not meet this standard.
An adequate mileage log must contain specific information for each business trip, including:
- The date of the travel
- The total distance or mileage of the trip
- The destination of the travel, noted by the city or town
- A clear business purpose for the trip, as general descriptions like “business” are insufficient
The employee must submit this documentation to the employer within a reasonable timeframe, which the IRS considers to be within 60 days of the expenses being incurred. Failure to provide this detailed and timely proof forces the employer to treat the entire reimbursement payment under non-accountable plan rules, making it fully taxable to the employee.
Calculating Taxable Income
The calculation of taxable income in a hybrid program involves a direct comparison of the fixed allowance and the substantiated mileage reimbursement at the end of each reporting period. The outcome determines if any portion of the allowance must be reclassified as wages.
Consider an employee who receives a $500 monthly car allowance and drives 600 business miles. Using the 2025 IRS standard mileage rate of 70 cents per mile, the total non-taxable reimbursement is $420 (600 miles x $0.70). Because the $500 allowance is greater than the $420 of substantiated expenses, the $80 difference is considered excess. This amount must be reported as taxable income on the employee’s W-2.
In another example, an employee with the same $500 allowance drives 800 business miles. The substantiated mileage reimbursement would be $560 (800 miles x $0.70). Since the substantiated reimbursement is greater than the allowance, the entire $500 allowance is non-taxable. The employer may also choose to pay the additional $60 to the employee as a tax-free reimbursement.