(November 20, 2007) The California Supreme Court has confirmed that employers may reimburse employees in one lump sum for expenses related to using personal vehicles for work.

In a November 5 ruling, the court said employers meet their obligation to reimburse employees for all necessary expenditures or losses relating to using their vehicles for performing their job duties by paying employees a lump sum reimbursement in addition to their wages, provided that wages and the reimbursement amount are clearly apportioned.

Employers and employees may agree through contract or otherwise to the actual amount of reimbursement. The amount of reimbursement must be sufficient to provide full reimbursement for all actual expenses necessarily incurred by employees to use their car for work. However, if employees believe that the reimbursement amount is insufficient, they must be able to legally challenge the employer, who must then make up the difference.

The court defined three reimbursement methods:

Actual Expense Method. The court noted that, although this is the most accurate reimbursement method, it is the most burdensome for employers and employees because the employee must keep detailed records of all actual expenses, including fuel, maintenance, repairs, insurance, registration and depreciation, and the employer must calculate the amount associated with each of these costs and reimburse the employee. The employer must also exercise judgment as to whether each expense was necessary. Few employers use the actual expense method.

Mileage Reimbursement Method. The employee need track only the number of miles driven to perform job duties and submit that information to the employer. According to the court, the IRS mileage reimbursement rate, which is based on a national average of the cost of operating a motor vehicle - including initial purchase/lease cost, repairs, maintenance, fluctuating fuel costs and cost of insurance - contemplates all reasonable costs associated with automobile expenses. The employer may use the IRS rate per mile to repay the employee. Because the IRS rate is an approximation of actual expenses, it is less accurate than the actual expense method, so an employee must be permitted to challenge the resulting reimbursement payment. An employer is still permitted to use a rate less than the IRS rate but retains the burden of demonstrating that the rate it uses reimburses employees for their actual expenses.

Lump Sum Payment. Employers pay a fixed amount instead of employees submitting documentation of expenses. The amount is generally based on employers' understanding of each employee's job duties, including the number of miles an employee routinely drives to perform the job duties. For example, if an employee is expected to use his/her own vehicle for work approximately 1,000 miles a month, multiply 1,000 miles by the current IRS rate to determine the most reasonable reimbursement amount. The court noted that this method is appropriate provided the lump sum is sufficient to provide full reimbursement for actual expenses incurred, and employees may still challenge the lump sum amount if they believe it is inadequate.

In its analysis, the court emphasized the importance of a workable and reasonable result when interpreting employers' requirement to reimburse employee expenses and saw no violation of the law in authorizing the use of the lump sum payment. Further, an employer may provide employees with enhanced compensation packages, as long as it provides some method or formula to distinguish between wages earned and expense reimbursement. Employers must also communicate to employees the method or basis for apportioning any increases in compensation between wages and expense reimbursement.

Best Practices

The CalChamber urges businesses to follow best practices when reimbursing their employees:

• Review and update your expense reimbursement policy to clearly communicate to employees how and when expenses will be repaid.
• Consult with your accountant or a tax expert before entering into an expense reimbursement contract with an employee to fully understand the tax implications of such an agreement.
• If you choose to reimburse at a rate less than the IRS rate, consult with legal counsel to ensure employees are being reimbursed for all actual costs associated with performing their job duties.

Staff Contact: Jessica Hawthorne