A new IRS Safe Harbor Rate is announced every year in mid-December, establishing a standard business mileage rate for the coming year. Many beverage companies think this rate should be used to reimburse field employees for their driving expenses; however, that’s not true. In fact, the IRS Safe Harbor Rate is actually not a recommended reimbursement rate, and using it as the basis for reimbursing your employees could cost you money in the long run.
So what is the IRS Safe Harbor Rate?
Set once per year, the IRS Safe Harbor Rate is calculated annually based on the average cost to operate a vehicle during the previous year. It is intended to be a basic cents-per-mile rate (i.e. a flat per-mile rate) that individuals can use to calculate a tax deduction for their unreimbursed driving expenses. The Safe Harbor Rate is really best suited for employees that do not drive often for business (less than 5,000 business miles/year) or are not reimbursed by their employers (typically 1099 or contract workers) and are looking for a simple way to write off business expenses on their taxes. The IRS allows any rate up to and including the Safe Harbor Rate to be reimbursed to employees on a tax-free basis, so long as they substantiate their mileage with compliant daily mileage logs (including each business trip’s to and from location, business purpose and mileage).
The biggest problem with using the IRS Safe Harbor Rate for reimbursement is that it’s calculated based on operating costs from the previous year, which means it’s inherently outdated (i.e. not reflective of current prices). Even further, the rate is based on national averages instead of location-specific costs.
For example, in 2015, the Safe Harbor Rate jumped from 56 cents to 57.5 cents per mile, at a time when gas prices were at five-year lows. At the time, the IRS and its third-party data provider defended the price increase by saying that the other costs associated with owning a vehicle – maintenance, insurance and depreciation for instance – had gone up, outweighing the decrease in fuel prices. However, in 2016 the rate plummeted 3.5 cents to 54 cents per mile, reflecting the low fuel prices seen in 2015, but not necessarily representative of current 2016 fuel costs.
The Safe Harbor Rate may be a simple and widely (mis)understood method for calculating tax-free reimbursements, but things like fuel prices vary greatly day to day and from city to city. A standard rate set for the entire year, encompassing the whole U.S., will be inherently inaccurate. Relying on the IRS rate for mileage reimbursement will not be capturing drivers’ true costs of operating their vehicle for business.
If the Safe Harbor Rate isn’t intended for reimbursement, what’s the alternative?
While many organizations mistakenly view the IRS Safe Harbor Rate as a recommended reimbursement rate, reimbursing an amount above or below the Safe Harbor Rate on a tax-free basis is allowed, but you’d better have the data to justify your calculations. The IRS’s only recommended reimbursement approach is the fixed and variable rate (FAVR) methodology, which calculates reimbursement rates based on an individual driver’s location and mileage-specific costs. It considers fixed costs such as insurance, license and registration fees, taxes and vehicle depreciation, as well as variable costs like gas, oil, maintenance and tire wear. FAVR reimbursements have the benefit of being paid tax-free under IRS Revenue Procedure 2010-51. This means that both employers and employees avoid paying taxes on the reimbursement amounts – a win-win.
Reimbursing drivers based on mileage and location-specific costs makes FAVR the fairest and most accurate reimbursement approach a beverage company can choose. It may seem more difficult to calculate and administer than simply using the IRS mileage rate for all drivers, but technology solutions exist that fully streamline the administration of FAVR – from aggregating the data necessary to calculate rates for each employee to automating mileage tracking and enforcing company and IRS policy. Coupled with the benefits of providing both accurate and tax-free reimbursements, FAVR is the logical choice for most companies.
If you’re still reimbursing your drivers based on the IRS Safe Harbor Rate, I encourage you to reconsider. By reimbursing each employee the right amount (like you do for all other T&E), you’ll eliminate over and under-reimbursements, providing cost savings for your organization and ensuring that all employees are treated fairly.