How Does a Car Allowance Work?

How Does a Car Allowance Work?

Posted on 22 April 2024

​How Does a Car Allowance Work?

For employees who need to use their personal vehicle for business purposes, many companies provide what is known as a car allowance. But what exactly is a car allowance?

A car allowance is essentially a set amount of money that an employer provides to an employee, in addition to their regular salary, as a contribution toward the costs of using their personal vehicle for business-related driving. Companies may implement a car allowance as an alternative to providing company cars to certain employees.

There are a few key car allowance benefits, and this is why companies opt for car allowance over company cars. It can be more cost-effective, it avoids the administrative burden of acquiring and maintaining a fleet of company vehicles, and it gives employees more flexibility and freedom with their choice of vehicle.

Types of Car Allowances:

There are different structures that companies can use when providing car allowance compensation. The main types include:

Fixed Car Allowance

A set amount is paid periodically, regardless of how many business miles were driven. This is simple but may overcompensate low mileage drivers.

Variable Car Allowance

The allowance amount varies based on the number of business miles driven each period. This aims to align compensation with actual driving needs.

Reimbursement-based Car Allowance

Employees track and submit mileage logs, then are reimbursed based on a per-mile rate for business miles driven.

Toy car, surrounded with a calculator and coins

What Influences Car Allowance Amounts?

The amount provided for a car allowance can vary significantly based on a few key factors. One major consideration is the employee's job role and requirements. Employees who are required to travel frequently for their job duties, such as sales reps regularly visiting clients, may receive a higher allowance than those with minimal driving needs.

Location and regional costs can also have an impact on the allowance level. Employees based in areas with higher overall vehicle operating costs may justify a bigger allowance.

Tax Implications of Car Allowances

Before implementing a car allowance program, companies need to consider a few important factors:

Tax Treatment of Car Allowances:

Car allowances are considered a taxable benefit and are added to an employee’s salary, this car allowance tax is set at the same rate as their annual salary which means they are paying Income Tax and National Insurance on this car allowance benefit.

Recordkeeping Requirements:

Even with flat allowances, employees and employers are still required to maintain mileage logs to substantiate business use. This can get complicated and if you forget to note down the mileage then you are at a loss.

Papers filled into a box

Reporting Car Allowances on Tax Returns:

Employees may be able to deduct qualified business expenses more than their car allowance on their tax returns.

Car Allowance vs Company Car

How does getting a car allowance compare to being provided with a company car for business use? There are some key pros and cons to consider for each option.

Car Allowance Benefits:

Employees have the freedom to be able to choose their own vehicle that suits their needs and preferences. There are fewer restrictions as they can freely use their vehicle for both work and personal use.

Car Allowance Restrictions:

Employees are responsible for all maintenance, insurance, and fuel costs associated with their personal vehicle. employees may be required to keep detailed records and report their business-related mileage and expenses for tax purposes, adding an administrative burden.

Blurry image of car driving in the sunset

Company Car Benefits:

Having a company car allowance can eliminate the hassles and costs of owning your own vehicle, saving employees from many recurring costs.

Company Car Restrictions:

Employees have limited choice in the vehicle they are assigned, this may not align with their personal preferences, ethics or needs. Additionally, there are typically restrictions on personal use, with strict guidelines on allowable mileage and usage.

Overall, a car allowance can be a good middle-ground solution for companies looking to cover employees' business driving needs cost-effectively while providing flexibility. However, companies need to structure their programs carefully to account for tax implications and recordkeeping burdens.

Make sure to check out our previous blog post for a more in-depth look at car allowance vs company car, which is the best option?

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