What Are Employee Business Expenses & Are They Deductible?
Navigate the complexities of employee business expenses, their tax implications, and employer reimbursement rules. Learn how to manage and document work-related costs.
Employee business expenses are costs employees incur to perform their jobs. These expenses arise directly from work duties. Understanding them is important for both employees and employers.
Understanding Employee Business Expenses
Employee business expenses are costs that are considered “ordinary and necessary” for an employee to perform their job. An ordinary expense is common and accepted in a particular industry or profession, while a necessary expense is helpful and appropriate for business, though not necessarily indispensable. These expenses must be directly related to the employee’s work and incurred in connection with their service to an employer.
Common examples of employee business expenses include travel expenses like airfare, lodging, and car rentals for business trips. Transportation expenses, distinct from regular commuting, such as car mileage, tolls, and parking for local business travel, also qualify. Work-related education, if required by the employer or necessary to maintain or improve job skills, can be an expense, but not if it prepares an employee for a new career. Tools, supplies, and uniforms required for the job and not provided by the employer are also included. Home office expenses may qualify, but only if the home office is used exclusively and regularly for the convenience of the employer.
For federal income tax purposes, the Tax Cuts and Jobs Act (TCJA) of 2017 suspended the deduction for unreimbursed employee business expenses for tax years 2018 through 2025. This means most out-of-pocket expenses are not deductible on federal tax returns during this period. While some states may still allow deductions, the federal suspension is a consideration.
Employer Reimbursement Arrangements
Employer reimbursement of employee business expenses impacts the tax treatment for employees. Reimbursement plans are categorized as either accountable or non-accountable, each with distinct tax implications.
Accountable plans are arrangements that meet Internal Revenue Service (IRS) requirements, making reimbursements non-taxable income for the employee. To qualify, three criteria must be met. First, expenses must have a business connection, meaning they are incurred while performing services as an employee.
Second, employees must provide adequate substantiation for their expenses to the employer within a reasonable period, within 60 days after the expense is paid or incurred. This substantiation involves providing documentation like receipts that verify the amount, time, place, and business purpose. Third, employees must return any excess reimbursement not substantiated within a reasonable timeframe, 120 days after the expense is paid or incurred or after receiving an advance. When these conditions are met, reimbursements are not reported as wages on the employee’s Form W-2 and are exempt from income and payroll taxes.
Conversely, non-accountable plans do not satisfy one or more accountable plan requirements. For instance, if an employer provides a lump-sum allowance without requiring substantiation or the return of unsubstantiated amounts, it is a non-accountable plan. Under a non-accountable plan, all reimbursements are taxable wages to the employee. These amounts are included in the employee’s gross income and reported on their Form W-2, subjecting them to income tax withholding and payroll taxes.
Essential Record Keeping for Expenses
Accurate record keeping is important for managing employee business expenses, even with current federal tax law changes. Documentation supports employer reimbursement requests and can aid potential state tax deductions or future federal tax law changes. Maintaining records also prepares individuals for an audit.
For each expense, details should be recorded. This includes the amount, time (date), place, and business purpose. For travel expenses, this may also include dates of departure and return, and destinations. Maintain receipts, invoices, mileage logs, and credit card statements as supporting documentation. The IRS requires documentary evidence for any lodging expenditure and for any other expense of $75 or more.
Methods for record keeping can vary, from physical files to digital applications and spreadsheets. Digital tools can streamline the process, allowing for easy capture and organization of expense data. Regardless of the method, the goal is to create a clear, comprehensive, and accessible record of all business-related outlays. This approach helps ensure compliance and facilitates financial reporting.