Can Reimbursements Be Taxed? What You Need to Know

Reimbursements, in an employer-employee relationship, are payments made by an employer to an employee for out-of-pocket expenses incurred on behalf of the business. These expenses arise during job duties or in connection with the employer’s trade or business. Whether these reimbursements are considered taxable income depends significantly on specific conditions and how the employer handles the process.

General Principles of Reimbursement Taxability

The Internal Revenue Service (IRS) operates on the principle that all income is taxable unless explicitly excluded by law. This applies to reimbursements, meaning payments from an employer to an employee, even if intended to cover expenses, can be considered income subject to taxation. A critical distinction exists between reimbursements for legitimate business expenses and those for personal expenses.

Reimbursements for personal expenses, such as a grocery bill or non-business vacation, are generally treated as taxable income to the employee and considered additional wages. Conversely, reimbursements for business expenses can be non-taxable if specific IRS rules are followed.

Accountable Plans and Tax-Free Reimbursements

For reimbursements to be tax-free, they must be made under an “accountable plan,” as defined by the IRS. An accountable plan is a reimbursement arrangement between an employer and an employee that adheres to specific Internal Revenue Code Section 62 guidelines. Meeting these requirements allows employees to receive reimbursements for work-related expenses without the payments being added to their taxable income.

To qualify as an accountable plan, the arrangement must satisfy three main requirements:
There must be a clear business connection, meaning the expenses have a direct business purpose related to the employee’s job or the employer’s operations.
The employee must provide adequate substantiation for the expenses to the employer within a reasonable timeframe, typically involving detailed records like receipts.
The employee must return any excess reimbursement (amounts not substantiated or exceeding actual expenses) to the employer within a reasonable period.

When a reimbursement plan adheres to these three requirements, the amounts reimbursed are generally not included in the employee’s gross income. These tax-free reimbursements are not subject to federal income tax withholding, Social Security, or Medicare taxes. Both the employer and employee must strictly follow these rules for the reimbursements to maintain their tax-free status.

Non-Accountable Plans and Taxable Reimbursements

A reimbursement arrangement is classified as a “non-accountable plan” if it fails to meet any one of the three requirements for an accountable plan. This includes situations where the employer does not require substantiation of expenses, allows employees to keep excess reimbursements, or if the reimbursement is for expenses that lack a business connection. For instance, if an employer provides a fixed allowance for expenses without requiring receipts or a return of unused funds, it typically falls under a non-accountable plan.

Reimbursements made under a non-accountable plan are treated as taxable wages to the employee. These amounts are included in Box 1 of the employee’s Form W-2, subjecting them to federal income tax withholding, Social Security, and Medicare taxes. Employees generally cannot deduct these expenses if they are reimbursed under a non-accountable plan, as the deduction for unreimbursed employee business expenses was suspended for tax years 2018 through 2025 by the Tax Cuts and Jobs Act (TCJA).

Applying Reimbursement Rules to Common Expenses

The distinction between accountable and non-accountable plans significantly impacts the tax treatment of various common employee expenses. Understanding how these rules apply to specific situations is important for both employers and employees.

Travel expenses, such as airfare, lodging, and meals incurred while away from home on business, are common examples. If an employee incurs these costs for a legitimate business purpose and provides proper documentation (receipts, dates, locations, and business purpose), reimbursement under an accountable plan is non-taxable.

Mileage reimbursement for using a personal vehicle for business purposes is another frequent scenario. Employers can reimburse employees using the IRS standard mileage rate or based on actual expenses. To be non-taxable, the reimbursement must be under an accountable plan, requiring the employee to substantiate the business miles driven with a log detailing dates, destinations, and business reasons.

Reimbursements for professional development or education are often encountered. If the education or training directly relates to the employee’s current job, maintaining or improving existing skills, and is not for a new trade or business, it may be non-taxable if reimbursed under an accountable plan. However, if the education qualifies the employee for a new line of work, the reimbursement could be taxable.

Cell phone and internet allowances also have specific tax implications. If an employer provides a cell phone primarily for non-compensatory business reasons, both business and personal use are generally non-taxable to the employee. Similarly, reimbursements for the business use of an employee’s personal cell phone can be non-taxable if required for business purposes and are reasonable.

Moving expenses, for most taxpayers, are generally no longer deductible or excludable from income for tax years 2018 through 2025 due to the TCJA. This means that reimbursements for moving expenses are typically taxable to the employee during this period. A key exception exists for active-duty military personnel who move due to a military order and a permanent change of station, for whom such reimbursements can remain non-taxable.