Clarifying Employee Reimbursement Calculations

Danielle Lackey

|

February 9, 2021

Over the last several years, there has been an influx of high-dollar lawsuits focused on how employers should reimburse their workers’ vehicle expenses. While litigation has focused largely on delivery driver contexts, there have also been a host of class-action lawsuits pertaining to under-reimbursement across other industries, including pharmaceuticals, retail and consumer goods. And reimbursement-related lawsuits outside of the vehicle space—in areas like mobile devices and remote work expenses—are on the rise.

In the case of drivers, plaintiffs’ attorneys frequently argue that because their clients (the employees) were not reimbursed at the IRS business deduction standard, their wages were reduced below minimum wage. Most courts reviewing this issue have concluded instead that the IRS rate is not required, and a reasonable approximation of the drivers’ expenses is appropriate under the Fair Labor Standards Act (FLSA), as well as under more stringent state reimbursement laws.

Buttressing this perspective, on August 31, the Department of Labor (DOL) issued a new opinion letter to address the hotly contested issue of driver reimbursements. Without endorsing any specific method, the letter concludes that in compliance with the FLSA’s minimum wage requirements, employers are permitted to reimburse employees who use their personal vehicle for work at a “reasonable approximation of actual expenses incurred.”

This means that to meet their obligations under federal wage and hour laws, employers do not need to reimburse employees at the IRS standard mileage rate. In fact, the IRS standard mileage rate may not always offer a reasonable approximation of expenses.

Implications for Businesses

For employers who seek to fairly reimburse their employees for the business use of their personal assets, there are a handful of key points to take away from this decision.

1. The IRS standard mileage rate is not always accurate. What many think of as the “IRS rate” is actually intended for business deductions, and is not always appropriate or legally defensible as a proxy for reimbursement costs. This is largely because the rate is a fixed, nationally averaged rate that does not account for driving costs that fluctuate based on geography and time of year. It is also based on cost data from the prior year. This means that businesses using the rate are likely to give reimbursements that do not reasonably approximate individual drivers’ driving costs.

In other words, by treating all employees’ expenses the same regardless of location or individual situations, reimbursements using the IRS rate create winners and losers by under-reimbursing drivers working in regions with above-average vehicle costs and over-reimbursing drivers working in below-average regions. The decision made in the recent lawsuit against Mountainside Pizza is a good example that used this reasoning.

2. The IRS rate is not the only way for employers to determine reasonably approximate expenses. There are several methods named in the letter that the DOL noted may reasonably approximate the expenses of using a personal vehicle for business purposes—and if so, comply with the FLSA. One of these methods includes the fixed and variable rate (FAVR) reimbursement methodology.

FAVR was designed to more accurately and fairly reimburse employees for the cost of driving for work by breaking payments down into fixed and variable expenses calculated from local data. Fixed costs (e.g., insurance, taxes, depreciation) are calculated for each driver based on where they live, while variable costs (e.g., gas, maintenance, tires) are calculated based on the miles an employee drives and the current prices that are specific to the employee’s driving territory, and which can vary based on location. For example, yearly vehicle property taxes are not the same in every state. Virginia property taxes average $1,011, while they average just $25 in Louisiana—a $986 difference per year.

These regional cost variations mean that a flat rate, like the IRS rate, will never “reasonably approximate” driving expenses as closely as a methodology based on actual, localized costs specific to where the employee operates, like FAVR.

3. There are implications beyond traditional delivery employees. Since the passage of California Assembly Bill 5 (AB5), which redefined the distinction between independent contractors and employees, app-based transportation and delivery companies have pursued various legal avenues to push back against this reclassification, and the associated increased costs. These efforts resulted in the passage of California Proposition 22, which allows ride-hail and delivery drivers to continue to be treated as independent contractors and be reimbursed 30 cents for each mile traveled to cover work-related expenses ranging from gas to mobile data. While the proposition provides that the 30-cent reimbursement rate will increase over time, it does so only at the Consumer Price Index—a relatively low increase that is unrelated to the actual cost increases for operating a vehicle (e.g., fuel costs) that may apply over time. By contrast, the IRS updates the IRS business deduction rate each year using actual cost data.

It is important to recognize that driving-related costs like fuel and insurance can vary widely across geographic areas—even within the same state—and change over time. A flat statewide per-mile stipend may not “reasonably approximate” in a manner that addresses cost differentials among workers.

4. Vehicles are not the only mixed-use asset employers should reimburse their employees for. 2020 may trigger such a dramatic shift in workforce structure that as much as 30% to 40% of the U.S. workforce could permanently spend more time working remotely than at an office. With the rise of remote work, mixed-use assets like mobile phones and home office expenses (e.g., high-speed internet, increased use of electricity, rent/mortgage) are other examples of employees using their personal assets for the benefit of their employer, and represent another area where it is equally important to ensure that businesses are getting reimbursement right.

While flat stipends or funneling home office costs through expense reports may appear easy to manage, guessing wrong regarding the stipend amount carries risks. These costs also vary based on location, so depending on an employee’s job responsibilities, the average national cost for home office expenses can range between $90 and $126 per employee per month. And regional costs diverge even more significantly. This means that on the one hand, under-reimbursing for home office costs—which constitute necessary job-related expenses—can result in employment law-related legal action. And over-reimbursing, if the flat stipend does not tie back to the business costs or lacks substantiation for example, can generate a tax underpayment susceptible to audit costs and penalties.

Beyond litigation, organizations that do not approach reimbursement for mixed-use assets accurately can also open themselves up to risks related to employee retention. Employees who do not view their employer’s reimbursement and compensation practices as fair or accurate will experience lower satisfaction at their jobs and ultimately decide to leave. Therefore, reimbursement is not only a financial or legal concern, but also a matter of competitive advantage.

The bottom line for employers is that the IRS business standard is not the holy grail of reimbursement. It is itself an approximation, and not the most reasonable, accurate or legally defensible option. With this latest guidance, employers should review how they handle reimbursements for their employees’ mixed-use assets, be it their cars or their remote work expenses.

Danielle Lackey is chief legal officer for Motus.