To tax or not to tax, that is the question. The IRS is pretty clear when it comes to the taxability of car allowances: Taxable.
If you provide a car allowance to an employee, the allowance is subject to federal income tax withholding and social security, Medicare, and federal unemployment taxes. It is also subject to state and local taxes. Because it is an allowance and employees are not required to provide receipts or other proof of expenses, it is considered a nonaccountable expense.
On the other hand, if you reimburse employees for mileage and other business expenses through an accountable plan – where you require employees to provide receipts – those reimbursements are not included in taxable wages.
Questions about the best way for your business to handle employee business expenses? Check with your accountant for strategic advice on this important issue.