As it does each year around this time, the IRS has released its 2021 business mileage standard rate, which now sits at 56 cents, a decrease of 1.5 cents from the previous year.

The 2021 IRS business mileage rate will go into effect January 1, 2021. The IRS business mileage standard rate offers U.S. employers a tax-free threshold for their reimbursements. This is important because, in many cases, organizations are required to reimburse mobile workers for the business use of mixed-use or personally-owned assets that are required for their jobs – such as vehicles.

What’s Behind This Year’s Rate Decrease?

While it may not feel surprising to see a lower rate in a down economy, this is only the second time in the past decade that there have been two consecutive rate reductions. The rate itself is calculated with data provided by Motus, which uses insights from the world’s largest retained pool of drivers to conduct statistical analysis of data from the prior year in order to inform the IRS about trends in business driving.

Trends from 2020 that affected driving costs include:

• Significantly lower fuel prices, which are on pace to finish approximately 17 percent below the national average when compared to 2019
• Slowed depreciation rates – caused in part by vehicle inventory shortages associated with the COVID-19 pandemic production stoppages – that have resulted in increased residual vehicle values
• Rising insurance premiums that, despite reduced travel and accident rates nationwide, are now 29 percent higher than they were a decade ago

How Should This Rate be Used?

For tax and accounting professionals working to apply the IRS business mileage standard rate for their clients, it’s important to understand what the rate is, and what it isn’t.

First, as a flat rate, the IRS business mileage standard doesn’t account for driving costs that fluctuate based on geography and time of year. That’s typically fine for low-mileage drivers who travel fewer than 5,000 business miles per year. Businesses using the rate to reimburse mid and high-mileage workers, however, are more likely to give reimbursements that do not reflect actual driving costs.

This has become an issue over the last several years with an influx of high-dollar lawsuits focused on how employers should reimburse their workers’ vehicle expenses. Many courts reviewing this issue have concluded that the IRS rate is not required, but employers must meet a reasonable approximation of the drivers’ expenses under the Fair Labor Standards Act (“FLSA”), as well as under more stringent state reimbursement laws.

The Department of Labor further underscored this point in an August 31 opinion letter. While the letter does not endorse any specific method, it states that employers are permitted to reimburse employees who use their personal vehicle for work at a “reasonable approximation of actual expenses incurred” in compliance with the FLSA’s minimum wage requirements.

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. By treating all employees’ expenses as the same regardless of location or individual situations, reimbursement using the IRS rate creates winners and losers by over or under reimbursing them for their costs.

Alternative Reimbursement Approaches

While organizations have regularly relied on the IRS business mileage standard for reimbursement, many are reevaluating their approach for 2021. The recent legal opinions and the economic turmoil of the past year have highlighted the corporate liability and amount of wasted spend that can often be associated with flat reimbursement.

One of the primary alternatives to the IRS business mileage standard rate is a more personalized approach, like the fixed and variable rate (FAVR) methodology. FAVR factors in fixed costs such as insurance premiums, registration and license fees, depreciation and taxes; as well as variable costs like fuel, maintenance, tires and oil, which all change based on mileage. It was designed to more accurately and fairly reimburse employees for the exact cost of driving for work and is paid tax-free under IRS Revenue Procedure 2019-46.

Regardless of which reimbursement tax and accounting professionals take, it’s vital to understand these different approaches and the legal and financial considerations tied to both.