What Are Employee Expenses & How Are They Reimbursed?

Employee expenses are costs employees incur directly related to their work, extending beyond regular salaries and wages. Understanding how these expenses are defined, what types are common, and how they are reimbursed is important for both employees and their organizations. This clarity helps ensure fair treatment for employees and compliance with tax regulations for businesses.

Defining Employee Expenses

Employee expenses are financial outlays made by an individual while performing job duties, distinct from personal living costs. The Internal Revenue Service (IRS) generally requires such expenses to be “ordinary and necessary” for the trade or business. An ordinary expense is common and accepted within a particular industry. A necessary expense is helpful and appropriate for the business, though it does not need to be indispensable.

For an expense to qualify, it must have a direct business connection, meaning it was incurred while the employee was performing services for their employer. This distinguishes work-related costs from personal expenditures, such as personal clothing or a daily commute. The expense must benefit the employer’s business operations. Costs failing these criteria are typically considered personal expenses, not reimbursable or tax-deductible.

Common Types of Employee Expenses

Employees frequently incur various types of expenses while fulfilling their professional responsibilities. These can range from costs associated with business travel to expenditures for professional development. Each category has specific considerations that determine its eligibility for reimbursement.

Travel expenses are among the most frequent employee outlays, including costs incurred when an employee is away from their tax home for business purposes. This encompasses airfare, train tickets, rental car fees, and lodging expenses like hotel stays. Incidental expenses, such as tips or fees for services, may also be included. Per diem allowances are sometimes used for meals and incidentals during travel, simplifying tracking by providing a fixed daily amount.

Meal and entertainment expenses frequently arise in business contexts, especially when employees are traveling or meeting with clients. While business meals for employees traveling away from home are typically reimbursable, entertainment expenses are generally no longer deductible for employers. However, certain business meals may still be 50% deductible if they meet specific criteria, such as a clear business purpose and proper documentation of attendees.

Home office expenses are incurred by employees who regularly and exclusively use a portion of their home for business. This means a dedicated space used solely for work activities, distinct from areas used for personal living. These expenses might include a portion of utilities, internet service, or office supplies used in the home office.

Professional development and education expenses relate to maintaining or improving skills required for an employee’s job. This category includes costs for specific certifications, continuing education courses, professional association dues, or subscriptions to industry publications. Such expenses are generally considered ordinary and necessary if they enhance job performance or are required to maintain a professional license.

Tools and supplies are common expenses, particularly for roles requiring specialized equipment not provided by the employer. This includes specific software, specialized hand tools, or materials consumed in the course of work. These items must be primarily for business use rather than personal benefit.

Communication expenses cover costs for business calls, internet access for work, or other communication services. For example, a portion of a personal internet bill might be reimbursable if the internet connection is regularly used for work from home. Similarly, a percentage of a cell phone bill could qualify if the phone is used significantly for business calls.

Uniforms and work clothing expenses are typically reimbursable if the attire is specifically required for the job and is not suitable for everyday wear. Examples include safety gear, specialized uniforms with company logos, or protective clothing. General professional attire, such as a suit or dress, is usually not considered a reimbursable expense as it is adaptable for personal use.

Employer Reimbursement Approaches

Employers handle employee expenses through various reimbursement methods, with significant tax implications. The two primary types are accountable plans and non-accountable plans. The distinction determines whether reimbursements are considered taxable income to the employee.

Accountable plans are preferred due to their favorable tax treatment. For a plan to be considered accountable by the IRS, it must satisfy three requirements. First, expenses must have a business connection, meaning they were incurred while performing services for the employer. Second, the employee must provide adequate accounting for the expenses, substantiating amounts, dates, places, business purpose, and the business relationship of those involved. This usually involves submitting receipts and detailed expense reports within a reasonable timeframe. Third, any excess reimbursement or advance not substantiated must be returned to the employer within a reasonable period. When these conditions are met, reimbursements under an accountable plan are not treated as taxable income to the employee and are not subject to income tax withholding or payroll taxes.

Conversely, a non-accountable plan fails to meet one or more accountable plan requirements. This occurs if an employer does not require expense substantiation or if employees are not required to return excess advances. Reimbursements under a non-accountable plan are treated as taxable wages to the employee. These amounts are included in the employee’s gross income, reported on their Form W-2, and are subject to federal income tax, Social Security, and Medicare taxes. This means the employee effectively pays taxes on the reimbursed amount.

Tax Treatment and Record Keeping

The tax treatment of employee expenses has changed significantly for federal income tax purposes. Most W-2 employees can no longer deduct unreimbursed employee business expenses on their federal tax returns. This means if an employee pays for a business expense out-of-pocket and is not reimbursed, they generally cannot claim a federal deduction. Some states may still allow deductions for unreimbursed expenses.

For employers, qualified employee expense reimbursements made under an accountable plan are generally deductible as a business expense. This allows businesses to recover costs associated with employees’ work-related outlays, reducing their taxable income. Deductibility depends on the employer maintaining an accountable plan adhering to IRS guidelines.

Accurate and detailed record keeping is important for both employees and employers. For employees, proper records are essential for timely reimbursement under an accountable plan. For employers, robust record keeping demonstrates compliance with IRS regulations during an audit and substantiates deductions.

Records should clearly document the “who, what, when, where, and why” of each expense. This includes the amount, time, place, business purpose, and business relationship of any individuals involved. For expenditures over $75 and all lodging expenses, detailed receipts or other proof of payment are generally required. For mileage, a log detailing dates, destinations, and business purpose is typically sufficient. Records should be maintained for a minimum of three years from the tax filing date and can be kept in an organized physical or electronic format.