What Is FAVR? Fixed and Variable Rate Reimbursement

Fixed and Variable Rate reimbursement, known as FAVR, is an IRS-approved way for employers to pay employees who drive their personal vehicles for work. It splits the payment into two parts: a fixed monthly amount that covers ownership costs like insurance and registration, and a variable per-mile amount that covers driving costs like fuel and maintenance. When the plan meets the requirements of Revenue Procedure 2019-46, the payments are tax-free to the employee and fully deductible for the employer.¹

The design solves a specific problem. Two employees can drive the same job in different cities and face very different real costs, because insurance premiums, registration fees, and fuel prices vary by location. FAVR uses localized cost data, so a driver in a high-cost metro receives a larger fixed payment than a driver in a low-cost rural area, even under the same company plan.

The Two Components

The Fixed Payment

The fixed portion covers costs an employee pays whether or not they drive a business mile in a given month: depreciation, insurance premiums, registration fees, and personal property taxes on the vehicle.¹ The employer calculates the amount from retail cost data in the area where the employee lives, then pays it every month as a predictable baseline.

The depreciation piece is capped. It cannot exceed the annual luxury automobile depreciation limits under Section 280F of the tax code, which are adjusted each year for inflation. That keeps employers from anchoring the payment to an unrealistically expensive vehicle.

The Variable Payment

The variable portion covers costs that rise and fall with driving: fuel, oil, tires, and routine maintenance. The employer sets a cents-per-mile rate using cost data from the area where the employee actually drives for work, then multiplies that rate by the substantiated business miles for the period.¹ A field rep who logs 2,000 business miles receives a much larger variable payment than one who logs 400.

How FAVR Compares to a Flat Allowance or the Standard Mileage Rate

A flat car allowance pays every driver the same monthly amount regardless of location or mileage. The IRS treats flat allowances as taxable wages, so a $600 allowance might net roughly $400 after income and payroll taxes.

The standard mileage rate reimburses a single national per-mile figure. For 2026, that rate is 72.5 cents per mile.² Properly documented, it is tax-free, but it applies the same rate to a driver in rural Mississippi and a driver in downtown San Francisco even though their actual costs are very different.

FAVR reaches a more accurate number because it uses local cost data and separates ownership costs from driving costs. Drivers in expensive areas receive higher fixed payments; low-mileage drivers receive smaller variable payments. The trade-off is administrative complexity: FAVR requires more documentation and stricter compliance than either alternative.

Who Qualifies

FAVR eligibility rules are stricter than those for the standard mileage rate, and failing any one of them can jeopardize the tax-free status of the entire plan.

At Least Five Participants

The plan must cover at least five employees at all times during the calendar year.³ That makes FAVR impractical for very small companies, and employers generally maintain a cushion above five to absorb turnover.

No Control Employees

Owners, officers, directors, and highly compensated workers classified as “control employees” under IRS regulations cannot participate.³ The rule blocks a plan designed primarily to benefit its architects.

Minimum Business Mileage

Each employee must substantiate at least 5,000 business miles per year, or 80 percent of total miles for business, whichever is greater. Employees who join mid-year get these limits prorated monthly. Separately, the annual business mileage projection the employer uses to build the allowance must be at least 6,250 miles for a full calendar year.¹

Vehicle Price and Age Limits

The employee’s vehicle must have a manufacturer’s suggested retail price at or below the annual FAVR cost limit. For 2026, that cap is $61,700 for automobiles, trucks, and vans.² The vehicle must also have cost at least 90 percent of the standard vehicle the plan uses as its benchmark. And it cannot exceed the retention period the employer defines, usually five to seven model years. Once a vehicle ages past that cutoff, continued fixed payments become taxable.

What Keeps the Payments Tax-Free

When a FAVR plan qualifies as an accountable plan, payments are excluded from the employee’s gross income and are exempt from federal income tax, Social Security tax, and Medicare tax.⁴ Employers deduct the payments as ordinary business expenses. That dual benefit is the whole point of running a FAVR plan.

Two conditions have to hold. The employee must substantiate every business expense to the employer with adequate records, and the employee must return any excess payments within a reasonable period. The IRS treats “reasonable period” as 120 days from a quarterly statement identifying unsubstantiated amounts.⁵ If either condition fails, the plan becomes non-accountable for that employee and the payments move to taxable wages on the W-2.

Contemporaneous Mileage Logs

Every employee must keep mileage records showing the date, destination, business purpose, and distance of each trip, recorded at or near the time of the trip. Reconstructed year-end logs are one of the most common reasons the IRS reclassifies reimbursements as taxable income.¹

Insurance Minimums

Each participant must carry vehicle liability coverage that meets the plan’s floor. Revenue Procedure 2019-46 sets that floor at $100,000 per person for bodily injury, $300,000 per accident for bodily injury, and $50,000 for property damage.¹ These limits exceed the state minimum in most places, so employees often need to raise their personal auto policies to participate.

Record Retention

The IRS generally requires records supporting income, deductions, or credits for at least three years after filing, extending to six years when unreported income exceeds 25 percent of gross income. For vehicle-related records that affect depreciation, the recommendation is to hold records until the statute of limitations expires for the year the vehicle is disposed of.⁶ Keeping FAVR records for at least six years is the safer practical approach.

Year-End Reconciliation

FAVR payments run on projected mileage during the year, and projections rarely match reality. At year-end, the plan must reconcile what was paid against what was actually driven. If the employee received variable payments for more miles than they substantiated, the excess has to come back. If the employee was not covered for part of the year, the corresponding fixed payments for that period also have to be returned.¹

The employee has the 120-day reasonable period to either substantiate more expenses or return the money. If that window closes without action, the employer must treat the excess as taxable wages and withhold income and employment taxes no later than the first payroll period after the reasonable period expires.¹

Switching Between FAVR and Other Methods

Moving between FAVR, the standard mileage rate, and actual expense tracking is possible, but the rules depend on whether the vehicle is owned or leased, and one path carries a lasting cost.

For a leased vehicle, the employee must use either the standard mileage rate or a FAVR allowance for the entire lease period, including renewals. Switching to actual expense tracking mid-lease is not allowed, and an employee whose lease expenses were substantiated under FAVR cannot later claim a deduction based on actual costs for the same vehicle.³

For an owned vehicle, an employee who switches from a FAVR allowance to actual expense tracking must use straight-line depreciation for the vehicle’s remaining useful life rather than the accelerated methods most taxpayers prefer.³ That effectively locks most drivers into whatever method they start with, so the choice is worth getting right at the outset.

1
Internal Revenue Service. Revenue Procedure 2019-46
2
Internal Revenue Service. Notice 2026-10
3
Internal Revenue Service. Revenue Procedure 2000-48
4
Office of the Law Revision Counsel. 26 USC 62 – Adjusted Gross Income Defined
5
Internal Revenue Service. Revenue Ruling 2005-52 – Section 1.62-2
6
Internal Revenue Service. How Long Should I Keep Records