Do You Get Taxed On the Car Allowance?
- MAZ
- 14 hours ago
- 12 min read
The Audio Summary of the Key Points of the Article:
Understanding Car Allowance Taxation in the UK
Now, let’s get straight to the burning question: Do you get taxed on a car allowance in the UK? Yes, a car allowance is taxed as part of your income. HM Revenue & Customs (HMRC) treats it like your salary, so it’s subject to income tax and National Insurance Contributions (NICs). But there’s more to it than a simple “yes.” Let’s unpack the details, explore how it affects your pay, and look at the numbers for the 2025/26 tax year.
What Exactly Is a Car Allowance?
So, what’s a car allowance anyway? It’s a cash sum your employer pays you, usually monthly, to cover the costs of using your own car for work. This could include buying, leasing, or maintaining a vehicle, plus expenses like fuel, insurance, and repairs. Unlike a company car, you choose the car and handle its upkeep. Typical allowances range from £3,600 to £10,300 annually, depending on your role and how much you drive for work, according to The Electric Car Scheme (2025).
Now, here’s the catch: because it’s paid as cash, HMRC sees it as part of your taxable income. It’s added to your salary before tax and NICs are calculated, which can bump you into a higher tax bracket if you’re not careful.
How Is a Car Allowance Taxed?
Let’s break it down. A car allowance is processed through your payroll under the Pay As You Earn (PAYE) system. Your employer reports it on your payslip, and HMRC deducts:
Income Tax: Based on your tax band (0%, 20%, 40%, or 45% in England for 2025/26).
Class 1 NICs: At 8% on earnings between £9,100 and £50,270, and 2% above £50,270.
For example, say you’re a marketing manager named Elowen earning £40,000 annually, with a £6,000 car allowance. Your total taxable income becomes £46,000. Assuming you’re in England, here’s how it shakes out for 2025/26:
Income Band | Rate | Taxable Amount | Tax Paid |
Personal Allowance (£12,570) | 0% | £12,570 | £0 |
Basic Rate (£12,571–£50,270) | 20% | £33,430 | £6,686 |
Higher Rate (over £50,270) | 40% | £0 | £0 |
Total Income Tax | £6,686 |
NICs Band | Rate | Taxable Amount | NICs Paid |
Up to £9,100 | 0% | £9,100 | £0 |
£9,101–£50,270 | 8% | £36,900 | £2,952 |
Over £50,270 | 2% | £0 | £0 |
Total NICs | £2,952 |
Total deductions: £6,686 (tax) + £2,952 (NICs) = £9,638. Without the allowance, Elowen’s deductions would be £8,086, so the extra £6,000 costs her £1,552 in tax and NICs, leaving £4,448 after tax. This shows the allowance isn’t “free money” — you lose a chunk to HMRC.
Why Does HMRC Tax Car Allowances This Way?
Now, you might be wondering: why does HMRC treat car allowances like salary? It’s because they’re a cash benefit with no strings attached. Unlike mileage reimbursements, which are tax-free up to HMRC’s Approved Mileage Allowance Payments (AMAP) rates (45p per mile for the first 10,000 miles, 25p after), a car allowance can be spent on anything — a car, a holiday, or a new sofa. HMRC doesn’t care how you use it, so they tax it upfront to keep things simple.
How Does It Compare to a Company Car?
Let’s consider this: a car allowance isn’t your only option. Many employers offer company cars, which are taxed differently as Benefits-in-Kind (BIK). The BIK tax is based on the car’s list price, CO2 emissions, and your tax band. For 2025/26, BIK rates range from 3% for zero-emission electric cars to 37% for high-emission vehicles (over 170g/km CO2).
Take Jago, a sales rep earning £50,000, who’s offered a £6,000 car allowance or a company car worth £30,000 with 130g/km CO2 emissions (31% BIK rate). Here’s a comparison:
Car Allowance: £6,000 is added to Jago’s salary, taxed at 40% (higher rate) + 2% NICs = £2,520 deductions, leaving £3,480.
Company Car: BIK value = £30,000 × 31% = £9,300. Taxed at 40% = £3,720. If the employer provides free fuel for private use, add another £9,870 BIK (£28,200 × 35%), taxed at 40% = £3,948. Total tax: £7,668.
The car allowance is cheaper tax-wise, but Jago must cover all car costs himself. The company car has higher tax but includes maintenance and insurance, saving hassle.
What About Business Mileage?
Be careful! If you get a car allowance, your employer might not reimburse business mileage separately. If they do, payments up to 45p per mile are tax-free. If they pay less (say, 30p), you can claim Mileage Allowance Relief (MAR) for the difference (15p per mile) at tax time. For 5,000 business miles, that’s £750 in relief, saving £150 for a 20% taxpayer. Keep a detailed log of dates, destinations, and trip purposes to satisfy HMRC.
Case Study: Lowenna’s Tax Surprise (2024)
Now, here’s a real-world example. Lowenna, a Cornish project coordinator, received a £5,000 car allowance in 2024. Her £35,000 salary pushed her to £40,000, just below the higher rate threshold. But a £3,000 bonus tipped her into the 40% band, increasing her tax on the allowance from £1,000 (20%) to £2,000 (40%). She didn’t track her 4,000 business miles, missing out on £1,800 in tax-free AMAPs. Lesson: always monitor your total income and log mileage.
Optimising Your Car Allowance and Navigating Tax Pitfalls
Now, you’ve got the basics of how car allowances are taxed in the UK, but let’s dig deeper. How can you make the most of your car allowance while keeping HMRC happy? This part is all about practical strategies for employees and business owners, real-world considerations for 2025, and avoiding costly mistakes. We’ll also explore how car allowances interact with other financial factors like pensions and electric vehicles, with fresh insights to help you save money.
How Can You Reduce the Tax Bite on Your Car Allowance?
Let’s face it: nobody loves seeing a chunk of their car allowance vanish to tax. But there are ways to soften the blow. The key is understanding how to offset the allowance with tax-free benefits or reliefs. Here’s how:
Claim Mileage Allowance Relief (MAR): If your employer reimburses business mileage below HMRC’s Approved Mileage Allowance Payments (AMAP) rates—45p per mile for the first 10,000 miles, 25p thereafter—you can claim the difference. For example, if Tamsyn drives 8,000 business miles in 2025/26 and her employer pays 30p per mile, she can claim 15p per mile (£1,200 total). As a 20% taxpayer, this saves her £240 via her tax return.
Track All Business Mileage: Use apps like Driversnote or a simple spreadsheet to log dates, destinations, and purposes. HMRC can reject claims without evidence, so don’t skimp on records.
Negotiate a Lower Allowance with Mileage Reimbursement: If your employer offers a high car allowance but no mileage payments, ask to swap part of it for tax-free AMAP reimbursements. A £4,000 allowance plus 45p per mile for 5,000 miles (£2,250, tax-free) could save you £800 in tax compared to a £6,250 allowance.
Should You Choose a Car Allowance or a Salary Sacrifice Scheme?
Now, here’s a game-changer for 2025: salary sacrifice schemes, especially for electric vehicles (EVs), can be more tax-efficient than car allowances. With EV adoption soaring—22% of new cars sold in the UK in 2024 were electric, per Carbuyer.co.uk—these schemes are worth a look.
In a salary sacrifice scheme, you give up part of your salary for a leased EV, reducing your taxable income. The car is taxed as a Benefit-in-Kind (BIK) at just 3% for zero-emission vehicles in 2025/26. Let’s compare for Kensa, earning £45,000 with a £6,000 car allowance option:
Car Allowance: £6,000 is taxed at 40% (higher rate) + 2% NICs = £2,520 deductions, leaving £3,480 to cover a car lease, fuel, and maintenance.
Salary Sacrifice for a £30,000 Tesla Model 3: Kensa sacrifices £400 monthly (£4,800 yearly), reducing her taxable income to £40,200. BIK = £30,000 × 3% = £900, taxed at 40% = £360. Total cost: £360 tax vs. £2,520 for the allowance. Plus, her employer saves 13.8% employer NICs (£662), which might sweeten the deal.
The catch? You don’t own the car, and lease costs vary. But for high earners, salary sacrifice often wins, especially with EV BIK rates staying low until at least 2028 (HMRC, 2025).
How Does a Car Allowance Affect Your Pension?
Be careful! A car allowance can quietly impact your pension contributions. Since it’s treated as salary, it’s pensionable income under most workplace pension schemes. For example, if Jory earns £50,000 plus a £6,000 allowance, his 5% pension contribution rises from £2,500 to £2,800, and his employer’s 3% contribution increases from £1,500 to £1,680. This boosts his retirement savings but reduces take-home pay.
However, some employers exclude allowances from pension calculations to cut costs. Check your contract—if your allowance isn’t pensionable, you might save cash now but lose out later. In 2024, a case study from ElectricCarScheme.com highlighted a Bristol manager who negotiated a pensionable allowance, adding £12,000 to her pension pot over 10 years.
What About Hybrid Workers with Low Business Mileage?
Now, consider this: if you’re a hybrid worker driving minimal business miles, a car allowance might not make sense. With 43% of UK employees working hybrid in 2025 (per GOV.UK labour stats), many face this issue. If Piran, a London-based analyst, drives just 2,000 business miles annually, a £5,000 allowance is mostly taxable income with little offset from AMAPs (£900 at 45p per mile).
Instead, Piran could:
Request a lower allowance with tax-free mileage payments.
Opt for a company bike scheme (tax-free under Cycle to Work) for short commutes.
Use public transport and claim tax-free travel expenses for business trips.
This saves tax and aligns with HMRC’s push for greener travel, per their 2025 sustainability guidelines.
How Can Business Owners Structure Car Allowances Tax-Efficiently?
So, you’re a business owner? Setting up a car allowance policy requires balancing employee satisfaction with tax compliance. Here’s a practical approach for 2025:
Offer Flexible Options: Provide a choice between a car allowance, company car, or salary sacrifice. A 2024 survey by The Electric Car Scheme found 68% of employees prefer flexibility.
Set Allowances Based on Role: Sales reps driving 15,000 miles need higher allowances (£8,000–£10,000) than office-based managers (£3,000–£5,000).
Reimburse Mileage Separately: Pay AMAP rates (45p/25p) to avoid employee tax claims and reduce payroll tax liability.
Report Accurately: Include allowances on P11D forms or payroll, and ensure mileage logs are audited. HMRC fined a Manchester firm £18,000 in 2023 for misreporting allowances as mileage.
Option | Pros | Cons | Best For |
Car Allowance | Flexible; employee chooses car | Taxed as income; employee covers costs | High-mileage roles |
Company Car | Covers maintenance; predictable costs | High BIK tax for non-EVs | Low-mileage roles |
Salary Sacrifice (EV) | Low BIK (3%); tax savings | No ownership; lease costs | Eco-conscious employees |
Case Study: Morwenna’s EV Switch (2025)
Here’s a fresh example. Morwenna, a Leeds-based HR director earning £60,000, took a £7,200 car allowance in 2024. After paying £3,024 in tax and NICs, she leased a petrol car, spending £4,000 yearly. In 2025, her employer offered a salary sacrifice scheme. She swapped her allowance for a £35,000 electric Audi Q4 e-tron (BIK 3%, £1,050). Her tax on the BIK was £420 (40%), saving £2,604 annually. Plus, she cut fuel costs with free workplace charging. Morwenna’s switch shows how EVs can transform tax outcomes.
What Happens if You’re Overtaxed?
None of us is a tax expert, but overtaxation is common with car allowances. If your allowance pushes you into a higher tax band or triggers an emergency tax code, you might overpay. In 2024, HMRC refunded £1.2 billion in overpaid tax, per GOV.UK. To fix this:
Check your payslip monthly for correct tax codes (e.g., 1257L for £12,570 personal allowance).
Contact HMRC via www.gov.uk/check-income-tax-current-year to adjust your code.
Claim MAR annually if mileage reimbursements are low, using form P87 or a self-assessment return.
Key Takeaways for Managing Car Allowance Taxation in the UK
Now, let’s wrap things up with the most critical points you need to know about car allowances and their tax implications in the UK. This section distills everything into concise, actionable insights to help you make smart decisions, whether you’re an employee or a business owner. Each point is a single sentence, summarizing the essentials for navigating this tax landscape in 2025/26.
Summary of the Most Important Points
A car allowance is taxed as part of your income, subject to income tax and National Insurance Contributions (NICs) through the PAYE system, reducing your take-home pay significantly.
For 2025/26, income tax rates in England are 20% (£12,571–£50,270), 40% (£50,271–£125,140), and 45% (over £125,140), with NICs at 8% (£9,101–£50,270) and 2% above £50,270.
Claiming Mileage Allowance Relief (MAR) for business miles below HMRC’s Approved Mileage Allowance Payments (AMAP) rates—45p per mile for the first 10,000 miles, 25p thereafter—can offset tax on your allowance.
Keeping detailed mileage logs with dates, destinations, and purposes is essential to satisfy HMRC and secure tax-free AMAP reimbursements or MAR claims.
A car allowance is often cheaper tax-wise than a company car, which is taxed as a Benefit-in-Kind (BIK) at 3% for electric vehicles up to 37% for high-emission cars in 2025/26.
Salary sacrifice schemes for electric vehicles, with a 3% BIK rate, can save thousands in tax compared to a car allowance, especially for higher-rate taxpayers.
Car allowances are usually pensionable, increasing your and your employer’s pension contributions, but some employers exclude them, affecting long-term savings.
Hybrid workers with low business mileage may find car allowances less tax-efficient and could benefit from alternatives like company bike schemes or tax-free travel expenses.
Business owners should offer flexible car policies, reimburse AMAP rates separately, and ensure accurate reporting on P11D forms to avoid HMRC penalties.
Regularly checking your payslip for correct tax codes and contacting HMRC to fix overtaxation can prevent costly mistakes, especially if your allowance pushes you into a higher tax band.
FAQs
Q1: **Can you claim tax relief on a car allowance if it’s not used for business purposes?**
A1: No, tax relief cannot be claimed on a car allowance if it’s not used for business purposes, as HMRC treats it as taxable income regardless of how it’s spent.
Q2: **What happens to a car allowance if an employee leaves their job mid-year?**
A2: The car allowance is taxed as income up to the point of leaving, and any overpayment or underpayment is adjusted through the final payslip or HMRC’s end-of-year reconciliation.
Q3: **Is a car allowance included in taxable income for Universal Credit calculations?**
A3: Yes, a car allowance is considered part of taxable income and is included when calculating eligibility for Universal Credit.
Q4: **Can you deduct car insurance costs from a car allowance for tax purposes?**
A4: Car insurance costs cannot be directly deducted from a car allowance, but business mileage expenses can be claimed under AMAP rates if applicable.
Q5: **Does a car allowance affect eligibility for tax-free childcare schemes?**
A5: A car allowance increases taxable income, which may reduce eligibility for tax-free childcare if total income exceeds the scheme’s thresholds.
Q6: **Can you receive a car allowance and a company car simultaneously?**
A6: It’s rare, but possible, depending on the employer’s policy; both would be taxed—the allowance as income and the car as a Benefit-in-Kind.
Q7: **How does a car allowance impact student loan repayments?**
A7: A car allowance is included in taxable income, increasing the amount subject to student loan repayments if earnings exceed the repayment threshold.
Q8: **Can you claim tax relief for car repairs if using a car allowance?**
A8: Car repair costs are not directly deductible, but business mileage claims under AMAP rates can cover a portion of maintenance expenses.
Q9: **Is a car allowance taxable if paid as a one-off lump sum?**
A9: Yes, a lump-sum car allowance is taxed as income in the tax year it’s received, processed through PAYE like regular payments.
Q10: **Can you opt out of a car allowance to avoid extra tax?**
A10: Employees can negotiate with their employer to opt out of a car allowance, potentially replacing it with other benefits or higher salary.
Q11: **Does a car allowance affect the tax on other benefits like private medical insurance?**
A11: A car allowance doesn’t directly affect the tax on other benefits, but it increases taxable income, which may push someone into a higher tax band.
Q12: **Can you claim VAT on expenses covered by a car allowance?**
A12: VAT cannot be reclaimed on expenses covered by a car allowance unless the individual is VAT-registered and the expenses are for business purposes.
Q13: **Is a car allowance considered earnings for maternity pay calculations?**
A13: Yes, a car allowance is typically included as earnings when calculating statutory maternity pay, depending on the employer’s payroll policy.
Q14: **Can you backdate mileage claims if receiving a car allowance?**
A14: Mileage claims can be backdated up to four tax years if proper records are maintained, allowing relief for unreimbursed business miles.
Q15: **Does a car allowance count towards the personal savings allowance?**
A15: A car allowance is earned income, not savings income, so it doesn’t directly affect the personal savings allowance.
Q16: **Can you receive a car allowance if self-employed?**
A16: Self-employed individuals don’t receive car allowances but can claim business mileage expenses directly through their tax return.
Q17: **How does a car allowance affect tax credits eligibility?**
A17: A car allowance increases taxable income, which may reduce eligibility for working tax credits or child tax credits.
Q18: **Can you claim tax relief for leasing a car with a car allowance?**
A18: Leasing costs cannot be directly deducted from a car allowance, but business mileage under AMAP rates can offset some leasing expenses.
Q19: **Is a car allowance taxable for non-residents working in the UK?**
A19: Non-residents are taxed on UK-sourced income, including car allowances, depending on their tax treaty and residency status.
Q20: **Can you negotiate a car allowance to be paid tax-free?**
A20: A car allowance cannot be paid tax-free, as HMRC requires it to be taxed as income, but employers can offer tax-free mileage reimbursements instead.
About the Author
Mr. Maz Zaheer, FCA, AFA, MAAT, MBA, is the CEO and Chief Accountant of My Tax Accountant and Total Tax Accountants—two of the UK’s leading tax advisory firms. With over 14 years of hands-on experience in UK taxation, Maz is a seasoned expert in advising individuals, SMEs, and corporations on complex tax matters. A Fellow Chartered Accountant and a prolific tax writer, he is widely respected for simplifying intricate tax concepts through his popular articles. His professional insights empower UK taxpayers to navigate their financial obligations with clarity and confidence.
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