Bookkeeping – Mileage Reimbursement (Lesson 61)
Some small businesses manage transportation costs in incremental payments by utilizing mileage reimbursement. It is a very advantageous system if used correctly. Other small businesses augment their existing vehicle fleet by paying employees via mileage reimbursement for the use of the employee’s automobile. Some simply take advantage of the tax benefit of the mileage deduction for tax purposes.
No matter how mileage reimbursement is used, it is the responsibility of the bookkeeper to track mileage reimbursement expenses for accounting and tax compliance purposes. To appreciate how mileage reimbursements work, this lesson breaks it down into four major sections. First, the bookkeeper needs to understand the formula and the two variations of the formula. Secondly, the bookkeeper/accountant must recognize that this method is an alternative method used when filing tax returns and how it is a tax basis difference. This includes the restrictions involved. Third, a good system that works with an employer/employee reimbursement relating to employees using their personal auto for their employer’s needs is explained. Finally, no system can operate efficiently without proper policies and documentation procedures.
Mileage Reimbursement Fundamentals
Up until several years ago the IRS allowed small business (single owner types) to claim mileage deduction (a value per mile driven) when using the owner’s vehicle for business purposes in lieu of purchasing a vehicle strictly for the business. The information is reported on Schedule C of Form 1040. This mileage deduction reduced paperwork and simplified the capitalization issues (purchasing a separate vehicle for the business).
Over time the IRS expanded this paperwork reduction to other forms of small business (S-Corporations, Partnerships and Trusts). Congress allows up to five vehicles to utilize the mileage deduction instead of using actual costs. However, the business must still track actual costs as explained in Lesson 60.
How is this so much more advantageous than actual costs?
The keys are hidden in the underlying elements of the IRS formula. Each year the IRS evaluates various costs including fuel, insurance, maintenance, repairs and depreciation From this information the IRS calculates what it determines is the cost to operate a vehicle each year using reasonable number of miles driven. The cost per mile over the last ten years has ranged from 46 cents to 58 cents. The current amount for 2017 is 53.5 cents per mile.
The most expensive variable is fuel with depreciation in a close second. Most businesses pay employees the going rate advocated by the IRS as reimbursement to the employee for the use of their car. Others opt out of the depreciation component and pay the mileage rate less the value for depreciation (about 17 cents/mile). This alternative reimbursement amount is approximately 38 cents per mile.
Tax Deduction Option
Small businesses with less than five vehicles may opt to use the mileage reimbursement amount as the deduction for tax purposes in lieu of actual costs. This is allowed for sole proprietorship, partnership, S-Corporation an a Limited Liability Company. Even though it is allowed, the business must still track actual costs to operate the fleet of vehicles.
There are several restrictions to using this tax deduction option. First the business may not have already started using actual costs on any one vehicle and then convert to the mileage deduction method. Secondly, any form of accelerated depreciation is disallowed for the vehicle(s). Accelerated depreciation includes Section 179, MACRS (Modified Accelerated Cost Recovery System) and bonus depreciation. Finally, the business must convert to actual costs if a fifth vehicle is added to the fleet. Conversion requires strict depreciation calculations on each of the existing vehicles setting the basis for future depreciation. Basically, the depreciation component taken to date via mileage deduction is subtracted from the original cost basis.
If the business uses the tax deduction option it must keep track of the book to tax basis for the company. The book basis tied to transportation will almost always exceed the tax basis. Look at the following schedule:
Book Basis Tax Basis
Net Profit w/Actual $48,719 $48,719
Actual Costs of Autos N/A 17,391 (Added Back -2 Vehicles)
Mileage Deduction N/A (25,643) 46,203 Miles @ .555/ea
Balance $48,719 $40,467
This basis issue comes into play when addressing ownership basis (capital accounts) or stock basis for tax purposes. Other than this, the mileage deduction benefits the owner by reducing his taxable income by the difference between actual costs to operate vehicles and the mileage rate deduction.
Now remember, the above deals with a business that owns these vehicles and restricts their operation to the business purposes. If the business does not own the vehicle then a simple reimbursement to the vehicle’s owner is appropriate. This is very common when employees use their personal auto to conduct business activity.
Employee Use of Personal Auto for Business Activities
There are many reasons for employers to reimburse employees for the use of personal autos for business purposes. They include:
A) Reduces cost of capital outlays for company vehicles;
B) Significantly reduces expenditures for:
– Repairs and Maintenance;
C) Lowers labor costs to track the actual costs to operate company vehicles;
D) Saves overall time for employees and employers.
This is very common in the service sector especially professional services like social work, engineering, patient home care and legal firms. Invariably, employees must travel to consult with clients, patients or appear in court. The simplest method to address transportation is via reimbursement for each mile traveled for the business.
The business either reimburses for the full amount as allowed by the IRS or it may opt to pay a lower amount per mile. If the employer pays less, the employee may deduct the difference using Schedule A of his/her Form 1040 tax return. The only problem is that the value for deductibility must exceed 2% of the employees’ gross income. Here is an example:
John travels for his company using his own vehicle. In 2015, John earns $67,000 in wages and travels 8,211 miles for business purposes. John is paid 41 cents per mile by the company as part of the company’s reimbursement plan. The IRS allows 55.5 cents per mile. John is allowed to deduct any personal business expenses in excess of 2% of his income. The following is his calculation:
Miles Driven @ 55.5 Cents/Mile 8,211 * .555 = $4,557
Reimbursement @ 41 Cents/Mile 8,211 * .41 = 3,367
Amount to Schedule A Paid by John $1,190
Threshold – 2% of Gross Wages $67,000 * .02 = 1,340
Excess Deductible Amount ($150)
John has not met the minimum threshold amount required. If John drove 10,500 miles, this is the result:
Miles Driven @ 55.5 Cents/Mile 10,500 * .555 = $5,828
Reimbursement @ 41 Cents/Mile 10,500 * .41 = 4,305
Amount to Schedule A Paid by John 1,523
Threshold – 2% of Gross Wages $67,000 * .02 = 1,340
Excess Deductible Amount $183
John is allowed to include $183 on his Schedule A Form 1040.
Employers pay a lower amount for mileage reimbursement for two primary reasons:
1) It is not unreasonable for employees to incur costs of 2% of their gross income to earn that income. This is the amount Congress considers normal and reasonable.
2) The difference between the IRS full amount and the lower amount is typically attributable to depreciation. Depreciation is usually a time driven function of value and employers feel that the decrease in value for the car occurs naturally even if not used for business purposes. I encourage those employers that only require minimal travel per year (less than 2,000 miles/year) from the employees to pay the lower rate as the minimal miles will not severely affect the auto’s value. If more than 2,000 miles per year, pay the IRS fully allowed amount so employees do not feel mistreated by their employer.
The best method of financial reimbursement is an addition to the employee’s paycheck. The additional amount is nontaxable for either income taxes or the Social Security and Medicare tax. However, any reimbursement in excess of the maximum allowed amount is taxable for both forms of tax. Employers do not pay more than the allowed maximum as the employer will have to pay its share of matching Social Security and Medicare tax.
Policies and Documentation
For mileage reimbursement there should exist three distinct policies as follows:
1) Reimbursement Amount – A paragraph indicating the employer reimburses mileage for business use of a personal vehicle at the rate in existence (or allowed) at that time by the IRS. If utilizing the lower amount indicate the IRS rate less 17 cents (or the amount allotted by the IRS for depreciation).
2) Proof of Insurance – Employees must turn in proof of insurance every six months or more frequently based on the auto policy’s renewal date.
3) Notification of Infraction – Employees must notify the employer of any driving violations within five business days of a moving violation. In addition, they must sign a D/BMV release form for copies of the employee’s driving record for human resources review.
A documentation procedure is necessary to report miles driven. I encourage a single form for each trip requiring a Google itinerary map justifying the miles. A summation spreadsheet is attached to the batch of trip tickets to summarize the number of miles driven. Use a cut-off date and a maximum outstanding period to turn in forms or there will be no reimbursement allowed. I suggest 30 days after the cut-off date or no reimbursement.
Scan all tickets and summary worksheets to both the employee’s folder and the mileage reimbursement account folder. Include mileage reimbursement as a child account under transportation expense or vehicle operations (cost of sales or expense).
There are several employees that are exceptions to all the above. This includes the owner, officers, directors and family members. The next article explains their reimbursement process in more detail.
Summary – Mileage Reimbursement
Mileage reimbursement is an alternative to the actual cost method of addressing the deductible amount for tax purposes. In addition it is a tool to reimburse employees for the use of their personal vehicles for business reasons.
The IRS sets the rate value each year. Employers may reimburse at the full amount or elect to use a lower value which generally excludes depreciation. Most employers utilize the full rate as the reimbursement amount.
The customary process is to include the dollar amount with the employee’s regular paycheck. The dollar value is a nontaxable addition (tax exempt amount) to the employee. Employees may deduct any actual costs in excess of the reimbursed amount contingent on the 2% rule via Schedule A of their Form 1040. Employees must provide documenting proof.
Employers should maintain policies mandating proof of insurance, reimbursement amounts and procedures; and requiring evidence of a good driving record. Furthermore, all mileage documentation is scanned and stored in both the employee’s folder and the vehicle expense folder. ACT ON KNOWLEDGE.
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