Employee Reimbursement and the IRS Rate Deductible (1/14/08)

The most common method of reimbursement of automobile expenses is to pay mileage based upon the IRS’s standard mileage deductible.  As of January 1, 2008, the IRS rate is 50.5 cents per mile, up from 48.7 cents per mile.  The recent California Supreme Court case reaffirms that this rate can be the basis on which employees are reimbursed.  If using this method, California employers must be careful that their policies and practices conform to both the recent California decision and the IRS deductible.

The California Supreme Court case, Gattuso v. Harte-Hanks Shoppers (42 Cal.4th 554. issued on November 5, 2007), primarily concerns itself with whether an employer can pay increased wages or commissions to comply with the requirement to cover employee expenses, instead of by separately reimbursing employees for actual expenses.  The case also sets forth requirements as to what must be communicated to the employee regarding employee expenses.

Methods of Covering Auto Expenses

Two traditional means by which an employer may satisfy the requirement to cover employee expenses are the “actual expense” method and the “mileage reimbursement” method.  The first method calls for an exacting consideration of each actual expense, including “fuel, maintenance, repairs, insurance, registration, and depreciation.”  While the most accurate, the actual expense method is also the most burdensome; not only does it require careful recordkeeping and reporting, but it also leaves room for disputes over whether each expense is “reasonable” – which would depend on evaluating employee choices, such as the expense and gas economy of the vehicle, brand and grade of gasoline, quality and cost of tires, etc. 

Using the mileage-reimbursement method, the employer reimburses the employee based on a predetermined rate per mile.  This rate can be based on an agreed rate or some standard index.  The index most commonly employed is the IRS standard mileage deductible.  In some situations, the IRS rate might not adequately compensate an employee for driving expenses, such as for those whose jobs require the use of larger trucks or transport vehicles.

At issue in Gattuso was the legality of a third method, the “lump sum” method, whereby “the employer merely pays a fixed amount for automobile expense reimbursement... generally based on the employer’s understanding of the employee’s job duties, including the number of miles that the employee typically or routinely must drive to perform those duties.”  This fixed amount is paid in addition to the employee’s salary or commission. 

Historically, the Labor Commissioner has preferred the mileage reimbursement method, and has taken the position that it will presume that an employer using this method has reimbursed vehicle expenses, unless an employee can prove that the mileage reimbursement was inadequate.  This puts on the employee the burden of quantifying depreciation and reasonable expenses, and separating personal and work-related insurance and registration costs.  In contrast, if the employer attempted to pay the actual expense or a lump sum, the Labor Commissioner expected the employer to prove that the amount paid was sufficient.  The Supreme Court embraced this approach, which gives the greatest protection to employers who pay the IRS rate for mileage.

Legality and Requirements of the Lump Sum Method

The plaintiff employees in the case argued that payment of a lump sum violated the Labor Code, because it does not correlate the reimbursement amount to the incurred expenses, and thereby fails “to guarantee reimbursement of employee expenses.”  The defendant employer, and the Supreme Court, disagreed.  So long as the lump sum “is sufficient to provide full reimbursement for actual expenses,” the Labor Code is satisfied.  However, an employee may still challenge the amount, if he can show that it is insufficient to fully reimburse the actual, reasonable expenses, or fails to equal the amount payable under the mileage reimbursement method.

Second, the plaintiff employees argued that the lump sum must be segregated from the base salary or commission, and could not be in the form of an increase to other compensation.  Here too the Supreme Court here disagreed.  Nothing in the statute precludes the overall increase – so long as the employer provides to the employee the method by which the expense reimbursement may be identified and distinguished from the total, combined compensation.   Of interest, the Court explained that the employer did not need to consider the tax implications for the employee when the lump sum was included with wages.

California Labor Code § 226(a) requires employers to provide an itemized statement “semimonthly or at the time of each payment of wages.”  Although § 226 does not specifically address the lump sum method of reimbursement, the Gattuso court stated that those employers which use the lump sum method “should ... separately identify the amounts that represent payment for labor performed and the amounts that represent reimbursement for business expenses” on the itemized statement (check stub).  Although this latter instruction is described as a “should,” rather than a “must,” the prudent approach is to follow the advice, and provide not only the method for identifying what is base salary or commission and what is reimbursement, but also clarify the amount for each.  Given the significant potential penalties for inaccurate or incomplete check stubs, employers should be sure to include any lump sum expense payments as separate line items.

COUNSEL TO MANAGEMENT:

In reimbursing for employee driving expenses, employers may opt for one of three methods: (1) reimbursement for actual, documented expenses; (2) reimbursement based on an agreed-upon rate per mile; or (3) a lump sum, based on estimated expenses.  The best approach remains to reimburse for mileage at the rate set by the IRS which as of January 1, 2008 is now 50.5 cents per mile.  Regardless of whatever method is used, an employee has the right to challenge the reimbursement amount or methodology, to ensure that it fully compensates for expenses actually and reasonably incurred.  For practical purposes, it will be difficult, if not impossible, for an employee to prove that mileage reimbursement at the IRS rate is inadequate.

The goal of this article is to provide employers with current labor and employment law information. The contents should neither be interpreted as, nor construed as legal advice or opinion. The reader should consult with Saqui & Raimondo at (831) 443-7100 in Salinas, or (916) 782-8555 in Sacramento for individual responses to questions or concerns regarding any given situation.