Are Business Expense Reimbursements Taxable?

Business expense reimbursements involve an employer paying an employee back for costs they incurred while performing duties for the business. This process allows employees to cover necessary work-related expenditures without using their personal funds.

Generally, these reimbursements are not considered taxable income to the employee. This helps ensure that employees are not financially penalized for expenses directly related to their work. The Internal Revenue Service (IRS) outlines specific criteria that must be met for these reimbursements to maintain their non-taxable status.

Requirements for Non-Taxable Reimbursements

For business expense reimbursements to be non-taxable to an employee, they must be made under what the IRS refers to as an “accountable plan.” Internal Revenue Code Section 62 establishes the specific conditions for such a plan. If a reimbursement arrangement satisfies these requirements, the amounts paid are excluded from the employee’s gross income.

The first requirement for an accountable plan is a “business connection.” This means the expense must have been paid or incurred by the employee while performing services for the employer. The expense must be directly related to the employer’s business activities. For instance, if an employer provides an allowance regardless of whether the employee incurs legitimate business expenses, this condition is not met, and the arrangement may be deemed an impermissible recharacterization of wages.

The second requirement is “substantiation,” which mandates that the employee must provide adequate accounting of the expenses to the employer. This involves submitting documentation such as receipts, invoices, or other records that detail the amount, date, place, and business purpose of the expense. An expense substantiated within 60 days after it is paid or incurred is considered to be within a reasonable period. The IRS requires documentation for expenses, with a limited exception for certain expenses under $75, excluding lodging.

The third requirement is the “return of excess” reimbursements. If an employee receives an advance or reimbursement that exceeds the amount of substantiated expenses, they must return the excess to the employer within a reasonable period. The IRS considers 120 days after the expenses were paid or incurred as a reasonable timeframe for returning excess amounts. Failure to return excess amounts or to substantiate expenses within these timeframes can cause the entire advance or reimbursement to become taxable wages.

When Reimbursements Become Taxable

When an employer’s reimbursement arrangement does not meet one or more of the three criteria for an accountable plan, it is classified as a “non-accountable plan” by the IRS. In such cases, all amounts paid to the employee under the arrangement are treated as taxable wages. This means the reimbursements are subject to federal income tax withholding, as well as Social Security and Medicare taxes (FICA).

For example, if an employer provides a flat monthly allowance for expenses without requiring any documentation or return of unspent funds, this would be a non-accountable plan.

The inclusion of these reimbursements as taxable wages increases the employee’s gross income, which can lead to a higher overall tax liability. Employers also incur additional costs, as they are responsible for their share of payroll taxes on these amounts. Failing to adhere to accountable plan rules can create unintended tax burdens for both the employee and the employer.

Typical Business Expenses Eligible for Reimbursement

Many types of business expenses are commonly reimbursed by employers under an accountable plan, provided they meet the IRS requirements. Travel expenses are a frequent category, including airfare, train tickets, lodging, and car-related costs like mileage. For mileage, employers can reimburse actual expenses or use the IRS standard mileage rate.

Meals incurred while traveling away from home on business are also commonly reimbursed, although they may be subject to specific limitations. For example, current tax law limits the deductibility of business meals to 50% of the cost. Other reimbursed expenses include office supplies, professional development courses, and certain equipment necessary for work duties.

While many expenses are eligible, some categories, like entertainment expenses, have specific rules. For tax years beginning after 2017 and before 2026, many entertainment, recreation, or amusement expenses are not reimbursable under an accountable plan. This means costs for activities such as theater tickets, country club memberships, or sporting events are not eligible for tax-free reimbursement.

How Reimbursements Appear on Tax Forms

The way business expense reimbursements appear on tax forms depends on whether they are made under an accountable or non-accountable plan. For reimbursements made under an accountable plan, the amounts are not considered wages and are not reported as income on the employee’s Form W-2, Wage and Tax Statement.

In contrast, if reimbursements are made under a non-accountable plan, they are treated as taxable wages. These amounts are included in Box 1 (Wages, Tips, Other Compensation) of the employee’s Form W-2, along with their regular salary or wages.

Employers must maintain detailed records to support their reimbursement practices, regardless of the plan type. This documentation is important for demonstrating compliance with IRS regulations, especially in the event of an audit. Accurate record-keeping helps ensure that reimbursements are correctly categorized and reported on tax forms, preventing potential issues for both the employer and the employee.