If your employer pays you a car allowance, have you stopped to consider the best way to spend it?
Being smart with your car allowance means considering your options. Owning versus financing. Keeping your current car, or finding one that better fits your needs. Compromising on your car budget to cover more maintenance and running costs, or keeping some of it as cash-in-pocket.
The right choices could reduce the amount of income tax or interest you pay, as well as making sure you're getting the best car and expenses coverage for your needs.
So, what is a car allowance exactly?
Your employer may pay you a car allowance to compensate you for the expense of using your own car for business purposes. An amount is typically paid into your bank account along with your salary. The breakdown between salary and car allowance should be stipulated on your payslip or in the terms of your employment contract.
Nominally, a car allowance is intended to cover the costs of operating your car, including fuel, tyres, repairs, maintenance, registration and insurance. In reality, how much of the allowance you actually choose to spend on your car, how much you put toward running costs, and how much you may choose to keep as extra cash-in-pocket is entirely up to you.
Does my current car fit the bill?
You need to decide if your current car meets your work and lifestyle requirements. If it does, it might make sense to simply treat the car allowance as additional cash-in-pocket, and put part of it toward running costs and any loan repayments of your current car.
If however, you're travelling long distances between work sites, towing trailers, or moving tools and stock, factors such as fuel efficiency, comfort, power and storage are important considerations. Also consider how you would like to use your car outside of work hours, how often you want to upgrade and how important ownership is to you.
We've built a handy calculator that lets you get a better understanding of how to calculate a car allowance and the impact it could have on a lease.
What are my finance options?
Depending on your specific circumstances, it's likely one of the following options will stand out as the best fit for your needs.
Option 1 – No Finance
Your first option is, of course, no finance at all. You pay for your current car's running costs using the cash you're paid as a car allowance. You will enjoy the flexibility to spend it how you wish, but the entire allowance is still treated as taxable income.
Option 2 – Commercial Finance
Many employees who get a car allowance will qualify for a chattel mortgage finance product. If most of your driving is done for business purposes, and you meet the application requirements, a chattel mortgage will typically offer you a better deal and more flexibility than other consumer loan products.
Alternatively, you may be eligible to apply for a car lease. While there's no option for trade in or deposits, and you should be aware of the fixed minimum residual values set by the ATO, this option gives you the flexibility to either payout the residual at the end of the term, or upgrade to a newer vehicle.
Option 3 – Consumer Loans
If you're not eligible for a commercial finance option, the other popular option is, of course, a car loan or secured personal loan. By using the car you're buying as security for the loan, you can lock in a great rate, but you won't be able to borrow above the value of the car you're buying.
If you have a home loan, you could use equity in your mortgage to buy a car. While this will typically offer you a low rate, unless you pay the extra borrowings off quickly, you may end up paying a very high amount of extra interest over the life of the loan – far higher than you'd pay with a typical three to five year car loan.
Option 4 – Novated Leasing (and salary packaging)
As an individual employee, your employer may offer you the option to forego a car allowance in favour of a novated lease, also known as salary packaging or salary sacrificing. Novated leasing allows you to pay for your car (and, in the case of a Fully Maintained Novated Lease, your operating costs) with your pre-tax income. A novated lease can save you GST and income tax, but it also gives you the convenience of a simple regular payment that covers all the expenses of owning and running your car.
Can I save on tax with a car allowance?
Receiving a car allowance doesn't, in itself, save you tax. It is a common misconception that a car allowance is automatically treated as tax-free income.
Regardless of the percentage of your car allowance spent on a work-related vehicle and its running costs, or what proportion of your driving is work-related, the entire allowance is treated as taxable income. This income may then be partly or wholly offset by claimable car-related tax deductions.
Even if your employer pays your car allowance as a gross or pre-tax payment (that is, they don't withhold income tax on car allowance payments), you still have to declare the full amount of the allowance when submitting your tax return, at which time it will be considered as taxable income.
If your employer offers Fully Maintained Novated Leasing, you may have the option of foregoing your cash-in-pocket car allowance and instead put it towards salary sacrificing a car, which may reduce your income tax and save GST. You don't need a car allowance to apply for a novated lease; it's simply an option if your employer offers salary sacrificing.
Ensure you seek expert advice, and also check out the ATO's website for more information.
So what can I claim as a tax deduction?
Simply put, at tax time you can claim a tax deduction for using your car for business purposes, in the same way that you could even if you didn't have a car allowance. The car allowance is simply additional income to help fund those work-related expenses, not a deductible expense itself.
You may be able to claim a range of costs related to the operation of your car. Exactly how you calculate them depends on which of the ATO's deduction methods suit you best. To learn more about cars and tax deductions, read our article on motor vehicle tax deduction eligibility and end of financial year tax reconciliation activities.
Being smarter with your car allowance
We want to help you be smarter with how you spend your car allowance so remember the following points:
- Considering all your options is the first step.
- It's also important to factor in all the expenses associated with a car.
- Opting for a less expensive car can be a good option, if your car allowance then also covers running costs such as fuel and maintenance; perhaps even registration and insurance.
If you have a car allowance and you're weighing up how to use it, speak with one of our finance specialists; they will compare finance options from a range of lenders, to find the best package for your needs.