What Are Reimbursable Expenses & How Do They Work?

Reimbursable expenses are out-of-pocket payments made by an employee or contractor for legitimate business purposes, which are then repaid by the company. They allow individuals to recover costs incurred while conducting activities on behalf of an organization. Understanding how these expenses are defined, their requirements for reimbursement, tax implications, and the general reimbursement process is important for both businesses and individuals.

Defining Reimbursable Expenses

A reimbursable expense is a cost an individual pays personally for a legitimate business purpose and is subsequently repaid by their employer or client. These expenses are distinct from personal outlays as they directly support the operations or objectives of the business. The Internal Revenue Service (IRS) generally considers an expense reimbursable if it is “ordinary and necessary” for the business, meaning it is common and accepted in the industry and helpful for the trade or business.

Common categories include travel-related costs, such as airfare, lodging, and mileage incurred when using a personal vehicle for business. Meals and entertainment expenses are also frequently reimbursed, especially when business-related, such as client meetings or meals during business travel. Other examples include office supplies, professional development fees, and costs associated with a home office setup, like internet or phone services, often limited to the business portion.

Requirements for Reimbursement

For an expense to be considered reimbursable, it must meet specific criteria: a clear business purpose, adequate accounting, and proper substantiation. The expense must have a direct business connection, meaning it was incurred while performing services for the employer or on behalf of the business.

Adequate accounting requires detailed record-keeping of the expense, including the amount, date, place, and business purpose. Substantiation through documentation is crucial, typically requiring receipts, invoices, or other verifiable records. Valid receipts usually include the date, amount, an itemized breakdown of what was purchased, the vendor’s name, and the payment method. For mileage, detailed logs documenting the business purpose, dates, destinations, and total miles driven are necessary.

Adherence to the company’s specific reimbursement policy is equally important. These policies often outline spending limits, approved vendors, and may require pre-approval for certain expenditures. Companies may also set their own, stricter rules regarding documentation or submission timelines than those required by the IRS.

Tax Treatment of Reimbursed Expenses

The tax treatment of reimbursed expenses depends on whether the employer’s reimbursement arrangement qualifies as an “accountable plan” or a “non-accountable plan” under IRS guidelines. An accountable plan must satisfy three main requirements: a business connection for the expense, adequate substantiation, and the return of any excess reimbursement within a reasonable period.

When reimbursements are made under an accountable plan, they are generally not considered taxable income to the employee. This means the reimbursed amounts are excluded from the employee’s gross income, are not reported on their W-2 form, and are exempt from income tax withholding and payroll taxes. This tax-free treatment benefits both the employee and the employer.

Conversely, reimbursements made under a non-accountable plan, or those that fail to meet the accountable plan criteria, are treated as taxable wages. These amounts are included in the employee’s gross income, reported on their W-2, and are subject to income tax withholding, Social Security, and Medicare taxes. Employers must report these payments as wages and withhold appropriate taxes. IRS Publication 463 provides guidance on these rules.

The Reimbursement Process

After an individual has incurred and properly documented a reimbursable expense, the process of receiving repayment typically begins with submitting an expense report. This report details each expenditure, its purpose, and the amount spent, often accompanied by the prepared documentation. These reports can be submitted through paper forms or via digital expense management systems.

Once submitted, the expense report undergoes an approval workflow, usually reviewed by a manager or the finance department to ensure compliance with company policy and IRS requirements. This review checks for the legitimacy of the expense, proper documentation, and adherence to any spending limits. Approved expenses are then processed for payment, with common reimbursement methods including direct deposit into the employee’s bank account or inclusion with their next paycheck. The timeline for reimbursement can vary, but companies often aim for prompt repayment, typically within a few business days to a few weeks.