Do I Pay Taxes on Reimbursed Expenses?
Learn whether reimbursed business expenses are taxable income. Understand the IRS rules that determine taxability and reporting for employees.
Reimbursed expenses can represent a significant financial aspect for many individuals, particularly those whose work requires them to incur costs on behalf of their employer. A common question arises regarding whether these reimbursements are subject to taxation. The tax treatment of reimbursed expenses is not always straightforward and depends on how an employer structures their reimbursement process. Understanding these distinctions is important for both employers and employees to ensure proper tax compliance and avoid unexpected tax liabilities.
Understanding Accountable Plans
An accountable plan is a reimbursement arrangement established by an employer that adheres to Internal Revenue Service (IRS) regulations, allowing for tax-free reimbursements to employees. To qualify, it must satisfy three distinct criteria that ensure expenses are legitimate business costs and are properly documented.
The first criterion is the “business connection” requirement: reimbursed expenses must be incurred while performing services for the employer. Costs must directly relate to job duties and serve a business purpose, not a personal one. Examples include business travel, certain meals, and mileage for business-related driving.
The second criterion is “adequate substantiation,” requiring employees to provide sufficient records to prove the expense. These records should detail the amount, time, place, and business purpose. Acceptable documentation includes receipts, invoices, or detailed logs, provided within 60 days after the expense was paid or incurred.
The final criterion, “return of excess reimbursements,” dictates that employees must return any amount received in excess of the substantiated expenses within a reasonable timeframe. A reasonable period for returning excess amounts is generally considered to be within 120 days after the expense was incurred. When all three of these conditions are met, reimbursements are typically not included in an employee’s gross income. Consequently, these amounts are not subject to federal income tax withholding, Social Security taxes, or Medicare taxes.
Understanding Non-Accountable Plans
In contrast to an accountable plan, a non-accountable plan is a reimbursement arrangement that fails to meet one or more of the three criteria. This can occur if expenses lack a clear business connection, are not adequately substantiated, or excess reimbursements are not returned. Failure to adhere to IRS guidelines reclassifies the reimbursements.
When reimbursements are made under a non-accountable plan, the amounts are considered taxable income to the employee. This means the reimbursements are treated as additional wages, much like regular salary or bonus payments. As a result, these amounts are subject to income tax withholding, as well as Social Security and Medicare taxes. Employers are required to include these amounts in the employee’s taxable wages, increasing the employee’s overall taxable income.
Tax Reporting of Reimbursed Expenses
The manner in which reimbursed expenses are reported on tax documents reflects whether the employer’s arrangement qualifies as an accountable or non-accountable plan. For reimbursements made under an accountable plan, the amounts are generally not reported as wages on the employee’s Form W-2. Because these reimbursements are considered non-taxable, they are excluded from the employee’s gross income and do not appear in Box 1 (Wages, tips, other compensation), Box 3 (Social Security wages), or Box 5 (Medicare wages) of the W-2 form.
Conversely, non-accountable plan reimbursements are treated as taxable wages. Employers must include these amounts in the employee’s gross pay, and they will be reported in Box 1, Box 3, and Box 5 of the employee’s Form W-2. This inclusion means the employee’s taxable income is higher, which can affect their overall tax liability.
The Tax Cuts and Jobs Act (TCJA) of 2017 significantly impacted employee expense reporting. For tax years 2018 through 2025, the TCJA suspended the deduction for miscellaneous itemized deductions subject to the 2% adjusted gross income (AGI) limit. This category previously included unreimbursed employee business expenses. Therefore, employees cannot deduct unreimbursed business expenses on their federal tax return during this period, highlighting the importance of accountable plans.