Are Reimbursements Taxable in California?

When employees incur costs as part of their job, employers often provide a reimbursement to cover those expenditures. In California, whether this repayment is considered taxable income depends on rules from the Internal Revenue Service (IRS). If an employer’s reimbursement policy meets the federal standard for an “accountable plan,” the money an employee receives is not taxable. This means the payment is treated as a repayment and not as additional wages. The process of how an expense is requested, documented, and paid is as significant as the nature of the expense itself.

The Accountable Plan Standard for Non-Taxable Reimbursements

The taxability of employee reimbursements is determined by whether they are provided under an IRS “accountable plan.” To qualify, a reimbursement arrangement must satisfy three specific tests. If all conditions are met, the payments are not considered wages and are excluded from an employee’s taxable income. This ensures that reimbursements are legitimate repayments for business costs and not disguised compensation.

The first requirement is a direct business connection. An expense must be an ordinary and necessary cost associated with performing job duties. This means the expenditure must be a common and accepted cost in that trade or business and helpful for the employer’s operations. Personal expenses, such as commuting costs from home to a primary workplace, do not meet this standard.

A second component is substantiation. The employee must adequately account for the expenses to the employer by providing documentary evidence. This involves submitting receipts, invoices, or a detailed log, such as a mileage record. The documentation must prove the amount, time, place, and business purpose of the expense within 60 days of when the cost was incurred.

The final test is the return of any excess reimbursement. If an employer provides an advance or a reimbursement that is more than the substantiated expenses, the employee is required to return the excess amount. This must occur within 120 days after the expense was paid or the advance was received. Failure to meet any of these requirements disqualifies the arrangement, causing it to be treated as a “nonaccountable plan,” where all reimbursements are reported as taxable income.

Applying the Rules to Common California Business Expenses

In California, California Labor Code Section 2802 mandates that employers must indemnify their employees for all necessary expenditures incurred as a direct consequence of their job duties. This state law makes reimbursement a legal obligation, separate from the federal tax treatment determined by the accountable plan rules. The law covers a wide range of costs to prevent employers from passing operating expenses onto their workers.

For vehicle and mileage costs, substantiation is achieved through a detailed mileage log. This record should contain:

• The date of the trip
• The starting and ending locations
• The total miles driven
• The business purpose of the travel

To calculate the reimbursement amount, many employers use the standard mileage rate set by the IRS. For 2025, the rate is 70 cents per business mile driven. Using this rate simplifies the process, as it is deemed to have substantiated the costs of operating the vehicle.

Travel expenses for business trips, including airfare, hotel stays, and meals, are also common reimbursements. To comply with accountable plan rules, employees must submit receipts for lodging and flights. For meals, employers may reimburse the actual cost based on receipts or use a standard per diem rate. Per diem payments cover meals and incidental expenses and do not require receipts, as long as the rate used does not exceed federal per diem rates for that location.

Other costs, such as tools, supplies, or software required to perform a job, are reimbursable if the accountable plan rules are followed. The employee must provide proof of purchase and demonstrate that the item is a necessary expense. For remote workers, this can extend to a reasonable portion of home office expenses, such as internet service, provided the employee can document the business-use percentage of that cost.

How Reimbursements Appear on Tax Forms

The distinction between accountable and nonaccountable plans directly impacts how payments are reported for tax purposes. When an employer’s policy qualifies as an accountable plan, the payments are not considered income. Consequently, these non-taxable reimbursements are not reported on the employee’s annual Form W-2, Wage and Tax Statement. The money is treated as a repayment of the employee’s own funds and is not subject to taxation or withholding.

This exclusion from the W-2 simplifies tax filing for the employee. The employer also benefits, since they are not required to pay their share of payroll taxes, such as Social Security and Medicare, on these amounts. The entire process occurs outside of the payroll system.

Conversely, if a reimbursement arrangement fails to meet the accountable plan requirements, it is classified as a nonaccountable plan. Under this classification, all reimbursement payments are treated as supplemental wages. The full amount must be included in the employee’s gross income, which is reported in Box 1 of the Form W-2.

These taxable reimbursements are subject to federal and state income tax withholding. They are also subject to Social Security and Medicare taxes, collectively known as FICA taxes. The employer withholds these taxes from the payment, and the reimbursement is taxed as ordinary income at the employee’s applicable marginal tax rate.