Vehicle Deductions for S-Corp Owners

Under an accountable plan, employer reimbursements for employees’ business use of a personal car can be excluded from wages if the plan meets three requirements: business connection, substantiation, and timely return of excess amounts. If any requirement is not met, reimbursements are treated as paid under a nonaccountable plan and are taxable wages subject to income tax withholding and employment taxes (FICA/FUTA) IRC § 62(c); Treas. Reg. § 1.62-2. Parallel employment tax regulations govern wage treatment of reimbursements and allowances for income tax withholding, Social Security (FICA), and FUTA (26 CFR § 31.3401(a)-4; 26 CFR § 31.3121(a)-3; 26 CFR § 31.3306(b)-2). Employers can reimburse either at the IRS standard mileage rate or for actual expenses; the policy choice affects substantiation burden, administrative simplicity, and tax risk Treas. Reg. § 1.62-2.

Accountable Plan Essentials

• Business connection. Reimburse only deductible employee business expenses (for car use, travel between business locations, visiting customers, etc.). Reimbursing non‑deductible commuting fails the business connection requirement; commuting is not a business expense and amounts paid are taxable wages Treas. Reg. § 1.62-2(d)(1)–(3); see IRS guidance on transportation and commuting in Publication 463 Publication 463.

• Substantiation. Employees must substantiate each expense by providing information sufficient to verify amount, time, place, and business purpose. Car use is “listed property” subject to strict substantiation under § 274(d); mileage logs typically must include date, destination, miles driven, and business purpose Treas. Reg. § 1.62-2(e); Publication 463, Recordkeeping.

• Return of excess. If advances or allowances exceed substantiated expenses, the excess must be returned within a reasonable period. Otherwise the excess is treated as paid under a nonaccountable plan and included in wages Treas. Reg. § 1.62-2(f)–(g).

Safe Harbors for Timely Substantiation/Return
The regulations provide two safe harbors: the fixed date method (advance within 30 days; substantiation within 60 days; return excess within 120 days) and the periodic statement method (no less frequently than quarterly statements with a 120‑day window to substantiate/return) Treas. Reg. § 1.62-2(g)(2).

Employment Tax Treatment and Reporting

• Excluded from wages when accountable. Reimbursements (or mileage/per diem allowances) that meet § 1.62‑2 are not wages for income tax withholding, FICA, or FUTA and need not be reported as taxable pay. If combined with wages in a single payment, the reimbursement must be specifically identified to remain excludable (26 CFR § 31.3401(a)-4(a); 26 CFR § 31.3121(a)-3(a); 26 CFR § 31.3306(b)-2(a)).

• Included in wages when nonaccountable or excess. If expenses aren’t substantiated, excess amounts aren’t returned, or the allowance exceeds deemed‑substantiated amounts (for per‑mile/per diem), the excess must be treated as wages and subject to withholding—generally no later than the first payroll period after the end of the reasonable period. For mileage/per diem allowances, any portion paid above the federal rate is wages when paid (or, for advances, by the first payroll period following the period in which the travel days/miles are substantiated) (26 CFR § 31.3401(a)-4(b); 26 CFR § 31.3121(a)-3(b); 26 CFR § 31.3306(b)-2(b); Treas. Reg. § 1.62-2(h)).

• W‑2 Box 12 code L. When reimbursements are accountable and include amounts deemed substantiated (e.g., federal mileage rates), employers generally report the nontaxable amount in box 12, code L, and include any taxable excess in boxes 1/3/5 of Form W‑2 Publication 5137; see also Instructions for Form 2106.

Two Reimbursement Methods

1. IRS Standard Mileage Rate Method

• What it is. Reimburse employees at a per‑mile rate for business miles driven in their personally owned or leased vehicles. For 2025, the IRS business standard mileage rate is 70 cents per mile. When an accountable plan uses the federal rate or less and the employee substantiates the time, place, business purpose, and miles, payments are deemed substantiated and excludable from wages; amounts above the federal rate are taxable wages to the extent of the excess Notice 2025‑05; Treas. Reg. § 1.62-2(e), (g), (h); 26 CFR § 31.3401(a)-4(b)(1)(ii).

• Substantiation. The employee must provide mileage logs or equivalent showing date, destination, miles driven, and business purpose. Receipts are not required for mileage itself, but lodging and other travel costs remain subject to receipt rules Treas. Reg. § 1.62-2(e); Publication 463.

• Administrative simplicity. Mileage reimbursements at or below the federal rate, with timely substantiation, can be excluded from wages without complex receipt collection. Employers must still audit for business connection (no commuting), adequate logs, and return of excess Treas. Reg. § 1.62-2(d)–(g); Publication 463.

• Considerations and constraints. The standard mileage rate approximates total operating costs; employees cannot both claim actual expenses and use the mileage rate for the same vehicle in the same period (relevant for those still eligible to file Form 2106). Mileage paid over the federal rate becomes wages for the excess. Commuting miles are not reimbursable tax‑free under an accountable plan and would be taxable if paid Notice 2025‑05; Instructions for Form 2106; Treas. Reg. § 1.62-2(d); Publication 463.

1. Actual Expense Reimbursement Method

• What it is. Reimburse employees for the actual out‑of‑pocket costs allocated to business use—such as fuel, oil, repairs, tires, insurance, registration fees, lease payments, and depreciation (if the employee owns the car)—based on the business‑use percentage. Employers can reimburse a pro‑rated share calculated from total annual costs × business‑use percentage, or pay specific receipts per trip with appropriate proration Publication 463.

• Substantiation. Employees must substantiate (a) the business‑use percentage with mileage logs for the year, and (b) the actual costs with receipts or other documentary evidence (generally required for expenses of $75 or more, and for all lodging). Listed property rules under § 274(d) apply, requiring detailed records of amount, time, place, and business purpose Publication 463; Treas. Reg. § 1.62-2(e).

• Administrative complexity. Actual method requires more robust documentation and employer review to ensure business connection, proper proration, and timely return of excess advances. Failure to substantiate converts payments to taxable wages under the nonaccountable plan rules Treas. Reg. § 1.62-2(c)–(h).

• Considerations and constraints. This method can more closely match costs (useful for high‑expense vehicles or unusual cost swings), but increases audit burden. Commuting costs are non‑deductible and cannot be reimbursed tax‑free. Where employee deductions are allowed (reservists, qualified performing artists, fee‑basis officials, or impairment‑related work expenses), employees must choose between mileage and actual for their own tax reporting and follow the method consistency rules for that vehicle Instructions for Form 2106; Publication 463.

Pros and Cons

• Standard mileage rate (70¢ per mile for 2025)

  • Pros:

    • Simpler substantiation (mileage log) and easier administration; deemed substantiated at or below the federal rate under an accountable plan Treas. Reg. § 1.62-2(e), (g).

    • Predictable costs and less risk of nonaccountable treatment when employees timely substantiate and return excess (26 CFR § 31.3401(a)-4; Publication 5137).

  • Cons:

    • May under‑ or over‑reimburse versus actual costs (e.g., highly expensive vehicles or very low operating costs).

    • Any reimbursement above the federal rate is taxable wages for the excess 26 CFR § 31.3401(a)-4(b)(1)(ii).

    • Strict prohibition on reimbursing commuting miles under accountable plans Treas. Reg. § 1.62-2(d); Publication 463; IRS PDF of Publication 463: https://www.irs.gov/pub/irs-pdf/p463.pdf.

• Actual expense reimbursement

  • Pros:

    • Can better reflect true costs where mileage rate is materially off, especially for high business‑use vehicles or atypical cost patterns Publication 463.

    • Flexibility to reimburse specific categories (fuel only, or fuel plus maintenance) with accountable substantiation.

  • Cons:

    • Heavy substantiation burden: receipts for each cost plus mileage logs for business‑use percentage; greater risk that missing documentation creates taxable wages (nonaccountable) Treas. Reg. § 1.62-2(e)–(h).

    • More complex review, proration, and period‑end reconciliations; stronger controls needed to ensure timely return of excess advances Treas. Reg. § 1.62-2(f)–(g).

Practical Methods and Policy Design

• Written accountable plan policy. Specify the method (mileage or actual), required substantiation (mileage logs; receipts), timing (fixed date or periodic statement safe harbors), and return‑of‑excess procedures. Make clear that commuting is not reimbursable and will be treated as taxable wages if paid Treas. Reg. § 1.62-2(d), (f)–(g); Publication 463.

• Mileage method implementation.

  • Require logs with date, starting/ending odometer or miles, origin/destination, and business purpose; reject commuting entries Publication 463.

  • Reimburse at or below the IRS rate (70¢ per mile for 2025) to avoid taxable excess; if paying above the rate, include the excess in wages when paid Notice 2025‑05; 26 CFR § 31.3401(a)-4(b)(1)(ii).

• Actual method implementation.

  • Require annual business‑use percentage substantiation via mileage logs and detailed receipts for all reimbursed costs; apply business‑use percentage to total costs or reimburse per‑trip with documented proration Publication 463.

  • Use the fixed date (30/60/120‑day) or periodic statement (quarterly + 120 days) safe harbors for advances and reconciliations Treas. Reg. § 1.62-2(g)(2).

• Payroll/withholding controls.

  • If substantiation is not received within the reasonable period or excess advances are not returned, treat the unsubstantiated/excess amounts as wages by the first payroll period after the reasonable period ends. For mileage/per diem allowances paid as advances, tax any excess rate portion by the first payroll period after the period in which the days/miles are substantiated 26 CFR § 31.3401(a)-4(b); Treas. Reg. § 1.62-2(h).

• W‑2 reporting.

  • Report taxable excess under nonaccountable rules in boxes 1/3/5; report substantiated accountable amounts in box 12, code L, when applicable (and do not include them in taxable wages) Publication 5137; Instructions for Form 2106.

Key Reminders

• Travel away from “tax home” and local transportation rules. Only reimburse travel/transportation that meets business purpose rules. The concept of “tax home” and the “temporary assignment” rules govern when travel is away from home vs. commuting; commuting is never deductible or reimbursable tax‑free Publication 463.

• Strict substantiation for cars. Car use is subject to § 274(d) listed property rules; without adequate records, neither actual nor mileage can be treated as accountable reimbursements. Inadequately substantiated amounts must be treated as wages Treas. Reg. § 1.62-2(e); IRS PDF of Publication 463: https://www.irs.gov/pub/irs-pdf/p463.pdf.

• Federal rate updates. Update policy annually to the IRS standard mileage rate; for 2025, 70¢ per mile applies to business use of an automobile Notice 2025‑05.

By choosing a reimbursement method aligned with your workforce and implementing a robust accountable plan (including timely substantiation and return‑of‑excess procedures), employers can avoid inadvertent wage treatment and employment tax exposure while fairly and efficiently reimbursing employees for bona fide business car expenses Treas. Reg. § 1.62-2; 26 CFR § 31.3401(a)-4; Publication 463; Notice 2025‑05.

This essay is not tax advice. Always consult a qualified tax professional for your specific situation.