Do I Have to Pay Tax on Reimbursement?

Reimbursement refers to the repayment of money an individual has spent on behalf of another party, usually an employer. This ensures individuals are not financially disadvantaged for out-of-pocket expenses incurred during professional duties. The taxability of these repayments is not always straightforward, depending on various factors and Internal Revenue Service (IRS) guidelines. This article clarifies when a reimbursement is considered taxable income and when it is not.

Reimbursements Not Subject to Tax

Many reimbursements are not considered taxable income, especially when they fall under an “accountable plan” as defined by the IRS. An accountable plan is an employer’s system for reimbursing employees for business expenses incurred while performing their duties. When a reimbursement meets these criteria, the amounts are excluded from the employee’s gross income and are not subject to income tax withholding or payroll taxes. This offers tax advantages for both the employer, who can deduct the expenses, and the employee, who receives the funds tax-free.

For a reimbursement to qualify under an accountable plan, it must satisfy three key rules established by the IRS. First, the expenses must have a “business connection,” meaning they were incurred for a legitimate business purpose while performing services for the employer. Second, the employee must “adequately account” for these expenses to the employer within a reasonable period, typically by providing proper substantiation like receipts, invoices, or detailed logs. The IRS generally considers 60 days after the expense was paid or incurred to be a reasonable period for substantiation. Third, the employee must return any “excess reimbursement” or allowance that exceeds the substantiated expenses within a reasonable period, usually within 120 days after the expense was incurred. Failure to return excess amounts can result in the entire reimbursement being treated as taxable.

Common examples of non-taxable reimbursements under an accountable plan include business travel expenses like airfare, lodging, and meals. Reimbursements for office supplies, tools, and professional development expenses directly related to job skills also qualify as non-taxable. Mileage reimbursements for the business use of a personal vehicle, calculated using the IRS standard mileage rate, are non-taxable, provided a detailed log of business mileage, destination, and purpose is kept.

Reimbursements Subject to Tax

Reimbursements that do not meet the criteria of an accountable plan are considered taxable income. These are referred to as “non-accountable plans.” When a reimbursement falls under a non-accountable plan, the entire amount is treated as taxable wages, subject to income tax withholding and all applicable payroll taxes, including Social Security and Medicare.

Examples of reimbursements that are typically taxable include payments made for personal expenses that lack a business connection. Stipends, which are fixed payments often given to employees to cover anticipated costs without requiring detailed substantiation or the return of unused funds, are also generally considered taxable income. For instance, a per diem payment that exceeds the IRS-established limits without proper substantiation for the actual expenses incurred would have the excess portion treated as taxable wages. Similarly, if an employee fails to adequately substantiate expenses or does not return any excess funds advanced by the employer within the reasonable timeframe, the entire reimbursement or the unreturned excess becomes taxable.

Certain fringe benefits provided by an employer are also considered taxable. For example, the personal use of a company car is a taxable non-cash fringe benefit. Its value is added to the employee’s taxable wages, and employers are responsible for calculating this value and withholding taxes. Moving expense reimbursements for non-military personnel are treated as taxable income for the employee, unless they are active duty military moving due to a permanent change of station.

Reporting Taxable Reimbursements

When reimbursements are considered taxable, employers are generally required to report these amounts as wages on the employee’s Form W-2, Wage and Tax Statement. This means the taxable reimbursement amount will be included in Box 1 (Wages, tips, other compensation), Box 3 (Social Security wages), and Box 5 (Medicare wages). Employers are also responsible for withholding federal income tax, Social Security tax, and Medicare tax from these amounts. Employees typically do not need to report these amounts separately on their tax returns if they are correctly included in their W-2 wages, as the employer has already accounted for them.

For tax years through 2025, most unreimbursed employee expenses are not deductible for federal income tax purposes for W-2 employees. This means if an employee incurs a business expense not reimbursed by an accountable plan, they generally cannot deduct it on their federal tax return. While some states may still allow deductions for unreimbursed employee expenses, this is not a federal provision.

For independent contractors or self-employed individuals, reimbursements are handled differently. If an independent contractor receives reimbursements for expenses, these amounts are included in the total income reported on Form 1099-NEC or Form 1099-MISC. Independent contractors then report this income, along with their other business income, on Schedule C (Form 1040), Profit or Loss from Business. They can then deduct their ordinary and necessary business expenses, including those for which they were reimbursed, on the same Schedule C, effectively netting out the reimbursement.