Employees' Guide To Car Allowance

Employees in many professions are expected to drive for work. Suppose your employer doesn't maintain a fleet of cars or provide a company car. In that case, you might be provided a car allowance instead.

This allowance can reimburse you for the car's purchasing and/or operational costs. But it's not required by law (besides in specific states), and your employer can also freely choose the amount or rate you're reimbursed.

How does a car allowance for employees work?

A car allowance is generally a set amount that your employer pays in addition to your regular salary each pay period. It's paid to offset vehicle-related expenses. In most cases, it is a fixed sum specified by your employer. 

A vehicle allowance for employees should cover the fixed and variable expenses you experience when using your car for business purposes. These include fuel, insurance, wear and tear, and other fees.

Fixed expenses and variable expenses 

When determining the car allowance amount, your employer should consider the impact of fixed and variable expenses. 

Variable expenses—like fuel or maintenance—not only vary from month to month for each individual employee but also depend on where in the country the employee lives and works.

Therefore, if you receive a fixed car allowance as part of your salary, make sure it is in line with your current expenses for maintaining your car. 

Learn how to keep your car allowance tax-free.

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Buying a car with a car allowance

Many employers choose to pay a vehicle allowance directly into your ordinary paycheck. Once paid, the money is yours and can be used to buy or lease a car. 

It is crucial to keep in mind that you will be the one purchasing the car. It will be your name on the contract. In some cases, you can provide a dealer with proof of your car allowance as evidence that you can make payments on a car loan. However, this may vary.

Maintaining your current vehicle with a car allowance

A vehicle allowance is intended to cover all your costs when using your private car for business purposes, including maintenance costs. That means it should cover regular wear and tear costs and maintenance such as oil changes.

You can divide these costs into fixed operational vehicle costs and variable ownership costs. 

Operational costs include, but are not limited to: 

• Fuel
• Oil 
• Maintenance
• Tires

While examples of ownership costs are: 

• Depreciation 
• Car insurance
• Vehicle license and registration fees

Also read: Car allowance vs. company cars - which is better for business? 

Receiving mileage reimbursement while getting a car allowance

You can still be reimbursed for your business mileage at the standard IRS rate even with a car allowance. In some states - like California - it's required by law.

IRS-approved reimbursement plans: FAVR program 

An FAVR plan reimburses employees through a combination of fixed and variable mileage payments. This has advantages because fixed payments can be tailored to costs for an employee's specific location and their actual mileage-related costs. Combining these two factors can help prevent under- or over-compensating employees for their expenses.

Are car allowances taxable?

Car allowances are taxable, just like your ordinary personal income. This makes it even more important to keep tabs on your expenses and how much you get out of the car allowance after taxes. 

However, if your employer reimburses you for the business mileage you drive in your personal vehicle, this is non-taxable as long as the rate by which you're reimbursed is not higher than the federal mileage rate determined by the IRS. 

See the federal mileage rates for 2025 and the 2024 mileage rates from the IRS.

You can even automate mileage tracking and ensure the mileage log is IRS-compliant with a mileage tracker app.
Some states require employers to reimburse you for all business travel-related expenses regardless of a car allowance. In this case, recording your business mileage carefully is crucial to present it to your employer for reimbursement.

Need more information about reimbursement for employees? Our guide provides an overview of reimbursement rules for employees.

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