Are Work Reimbursements Taxable?

Work reimbursements are a common aspect of employment, covering expenses employees incur while performing their job duties. The taxability of these reimbursements often presents a point of confusion for both employees and employers. Understanding how these payments are treated for tax purposes is important for accurate financial reporting and compliance with tax regulations. This involves distinguishing between different types of reimbursement arrangements.

Understanding Reimbursement Taxability

The tax treatment of work reimbursements depends on whether the employer’s reimbursement arrangement qualifies as an “accountable plan” or a “non-accountable plan” under tax law. If an arrangement meets specific criteria, reimbursements are generally not considered taxable income to the employee. Conversely, if the arrangement does not satisfy these requirements, the reimbursements are treated as taxable wages. This distinction is central to determining whether an employee will owe taxes on amounts received for work-related expenses.

An accountable plan allows employers to reimburse employees for business expenses without the reimbursements being subjected to income tax. This means the employee does not pay income tax on these amounts, and they are not included in their gross income. In contrast, a non-accountable plan treats all reimbursements as taxable income to the employee. This fundamental difference dictates how reimbursements impact an employee’s tax liability and an employer’s payroll obligations.

Key Elements of Accountable Plans

For an employer’s reimbursement arrangement to be considered an accountable plan, it must satisfy three specific requirements set forth by tax regulations. These conditions ensure that reimbursements are indeed for legitimate business purposes and are properly managed. If any of these three conditions are not met, the entire reimbursement, or at least the specific reimbursement in question, typically defaults to being treated under a non-accountable plan.

First, the expenses must have a business connection.

This means the expenses must be incurred in connection with the employee’s performance of services for the employer. The expenses must be ordinary and necessary for the employer’s business, directly related to job duties, and not personal expenses. Examples include business travel, mileage, and supplies used for work.

Second, employees must adequately substantiate these expenses to the employer within a reasonable period.

Adequate substantiation typically involves providing detailed records, such as receipts, canceled checks, or other documentation. These records should include the amount, date, place, and business purpose of the expense. For instance, the IRS generally considers substantiation within 60 days after the expenses were paid or incurred to be a reasonable period.

Third, employees must return any amount reimbursed in excess of the substantiated expenses within a reasonable period.

If an employee receives an advance for expenses, they must account for it and return any excess funds. A common guideline for returning excess amounts is within 120 days after the expenses were paid or incurred.

Tax Treatment of Reimbursements

This treatment affects how reimbursements are reported on tax forms and whether they are subject to various payroll taxes. Adhering to the correct treatment is important for compliance.

Under an accountable plan, reimbursements are not included in the employee’s gross income.

This means these amounts are not subject to federal income tax withholding, Social Security tax (FICA), or Medicare tax. Furthermore, employers do not report these non-taxable reimbursements as wages in Box 1 of the employee’s Form W-2, but may report them in Box 12 using specific codes.

Conversely, reimbursements made under a non-accountable plan are treated as taxable wages.

These amounts are subject to income tax withholding, Social Security, and Medicare taxes (FICA), and federal unemployment tax (FUTA). Non-accountable plan reimbursements are included in the employee’s gross wages reported in Box 1 of their Form W-2, and typically also in Box 3 (Social Security wages) and Box 5 (Medicare wages).

Employees generally cannot deduct unreimbursed employee business expenses on their federal income tax return.

The Tax Cuts and Jobs Act of 2017 suspended miscellaneous itemized deductions subject to the 2% adjusted gross income limit for tax years 2018 through 2025. This suspension includes most unreimbursed employee business expenses, making the proper classification of employer reimbursement plans even more significant for employees.

Maintaining Proper Records

Maintaining diligent records is important for both employees and employers regarding work reimbursements. This practice ensures compliance with tax regulations and provides necessary documentation in the event of an audit or inquiry.

Employees should keep copies of all expense reports submitted, along with supporting documentation such as receipts, invoices, and mileage logs.

These records serve as proof of the expenses incurred and the reimbursements received, helping to verify compliance with the employer’s accountable plan. Keeping records of communication related to reimbursements can also be beneficial.

Employers must maintain detailed records of their reimbursement policies, submitted expense reports, and proof of reimbursement payments.

This includes documentation outlining the specific criteria for their accountable plan and how it is administered. These comprehensive records are necessary for demonstrating adherence to tax laws and for resolving any discrepancies that may arise during tax preparation or an audit. Generally, tax records should be kept for at least three years after filing a tax return, though certain situations may require longer retention.