How to Reimburse Employees for Expenses

Employee expense reimbursement is a standard practice where businesses repay employees for work-related costs they personally covered. This process ensures employees are not financially burdened by necessary business expenditures, while also allowing companies to maintain accurate financial records. Establishing a clear system for these reimbursements helps manage company spending and ensures adherence to tax regulations.

Understanding Reimbursement Plan Types

Businesses primarily utilize two types of expense reimbursement plans: accountable and non-accountable. Under an accountable plan, reimbursements are generally not considered taxable income to the employee and are not subject to income tax withholding or payroll taxes. This favorable tax treatment also extends to the employer, as these reimbursements are typically deductible as ordinary and necessary business expenses.

Conversely, a non-accountable plan treats reimbursed amounts as taxable wages for the employee. These reimbursements are included in the employee’s gross income, are reported on their Form W-2, and are subject to income tax withholding and all applicable payroll taxes. For the employer, this means increased payroll tax liabilities. Non-accountable plans often involve less stringent documentation requirements for employees, such as a flat monthly allowance without requiring detailed receipts, but this convenience comes with significant tax implications.

Establishing an Accountable Plan

To qualify as an accountable plan under Internal Revenue Service (IRS) regulations, an expense reimbursement arrangement must meet three requirements. First, expenses must have a clear business connection, meaning they were incurred while performing job duties for the employer’s trade or business. Personal expenses are not eligible for reimbursement. Second, the employee must adequately account for these expenses to the employer within a reasonable period. This accounting requires detailed documentation, such as receipts, invoices, or canceled checks, that verify the amount, time, place, and business purpose of each expense.

Third, the employee must return any excess reimbursement or advance within a reasonable period. Failure to return excess amounts can result in the entire reimbursement being treated as if it were paid under a non-accountable plan, leading to taxation. Employers establish an accountable plan by creating a written policy that clearly outlines these requirements. This policy should specify what information and documentation employees must provide for substantiation, ensuring consistent compliance with IRS guidelines.

Common Employee Expenses

Businesses frequently reimburse employees for various work-related costs. Business travel expenses are a common category, encompassing airfare, lodging, and transportation costs like taxis or rental cars. Meals and entertainment expenses are also often reimbursed, though generally only 50% of qualifying business-related meal expenses are deductible for the business.

Mileage reimbursement covers the costs of using a personal vehicle for business purposes. Employees must maintain detailed logs documenting the business purpose, dates, destinations, and total miles driven for each trip. Other common reimbursable expenses include office supplies and equipment purchased by the employee, professional development costs such as training or conference fees, and telecommunication expenses like business phone or internet usage.

Executing the Reimbursement Process

The reimbursement process begins with the employee compiling an expense report. This report details each expenditure, its purpose, and the amount spent, and must include supporting documentation like receipts or invoices. Many companies establish specific timelines for submission to ensure timely processing and compliance. Employees typically submit these reports to their manager or a designated finance team member for review and approval.

The employer’s review process involves verifying that the submitted expenses comply with the company’s established reimbursement policy and meet all documentation requirements. After approval, the reimbursement is processed, commonly through direct deposit into the employee’s bank account or as a separate payment via check. Some companies may integrate reimbursements with regular payroll, detailing the amount on the employee’s payslip. Maintaining accurate internal records of all reimbursed expenses is important for auditing and tax purposes.

Tax Reporting for Reimbursed Expenses

The tax reporting of reimbursed expenses depends on whether the employer operates an accountable or non-accountable plan. For reimbursements made under a qualifying accountable plan, the amounts are generally excluded from the employee’s gross income. This means these reimbursements are not reported as wages on the employee’s Form W-2 and are not subject to income tax withholding or payroll taxes. Employers can typically deduct these properly substantiated reimbursements as business expenses.

In contrast, if reimbursements are made under a non-accountable plan, they are considered additional taxable wages to the employee. These amounts must be included in Box 1 of the employee’s Form W-2, along with regular salary or wages. Consequently, these reimbursements are subject to federal income tax withholding and all applicable payroll taxes, including Social Security and Medicare taxes. Employees receiving reimbursements under a non-accountable plan generally cannot deduct these expenses on their personal tax returns.