What Are Substantiated Employee Business Expense Reimbursements?

An employee business expense reimbursement is a payment from an employer for work-related costs an employee paid out-of-pocket. When substantiated under Internal Revenue Service (IRS) guidelines, these payments provide tax benefits. For the employee, a substantiated reimbursement is not considered taxable income, meaning it does not increase their tax liability or appear as wages on their Form W-2. For the employer, these reimbursements are deductible business expenses that lower the company’s taxable income. This tax-favored treatment requires the employer to establish a formal reimbursement arrangement known as an accountable plan, which determines if the payment is a non-taxable repayment or taxable wages.

The Accountable Plan Framework

To provide tax-free reimbursements, an employer’s policy must qualify as an “accountable plan.” The IRS requires a plan to meet three conditions. If any condition is not met, the arrangement is considered a “non-accountable plan,” resulting in different tax consequences. The three requirements are:

• It must have a business connection. This means any reimbursed expense must be an ordinary and necessary cost directly related to the employee’s job duties. An ordinary expense is common in a particular business, while a necessary expense is helpful and appropriate for the job.
• The employee must adequately substantiate expenses to the employer within a reasonable period.
• The employee must return any excess reimbursement or allowance within a reasonable period. For example, if an employee receives a cash advance for a trip and spends less than the advanced amount, the remainder must be returned to the employer.

Elements of Adequate Substantiation

Adequate substantiation is the process of proving a business expense to an employer. This requires a written record, like a log or expense report, and documentary evidence, like receipts or invoices. Together, these items must establish four elements:

• The amount of the expense.
• The time and date it was incurred.
• The place it occurred.
• The specific business purpose.

The written record can be a diary, account book, or a digital expense tracking application. For example, a record for a business lunch must include the cost, date, restaurant name and location, and the business topic discussed. Without a documented business purpose, an expense may not qualify for reimbursement.

Documentary evidence, such as itemized receipts or paid bills, supports the written record. The IRS requires this proof for any lodging expense and for any other single expense of $75 or more. A credit card statement alone is not sufficient because it is not itemized. For instance, an itemized hotel bill is needed to separate the room cost from personal charges like in-room movie rentals.

For business meals, additional substantiation is required. The employee must document the names, titles, and company affiliation of the people involved. This information, along with the business purpose, proves the meal was not a personal expense.

Common Substantiation Methods and Allowances

The IRS allows standardized rates to simplify record-keeping for common expenses like travel and vehicle use. These methods, such as per diem allowances and the standard mileage rate, satisfy the substantiation requirement for the amount of an expense. The employee must still document the time, place, and business purpose.

A per diem is a fixed daily allowance for lodging, meals, and incidental expenses during business travel, allowing an employee to receive a set amount instead of collecting receipts. The General Services Administration (GSA) sets the rates, which vary by location. Using these rates proves the expense amount, but the employee must still record the trip’s purpose, dates, and locations.

For business use of a personal vehicle, employers can use the standard mileage rate set annually by the IRS. For 2025, the rate is 70 cents per mile, which covers variable costs like gas, oil, and routine maintenance. When using this method, an employee does not need to save receipts for these operating costs.

To substantiate vehicle expenses with this method, the employee must keep a detailed driving log. The log must include the date, start and end locations, total miles, and the business purpose for each trip. The reimbursement amount is the total business miles multiplied by the standard rate. Tolls and parking fees are not included in this rate and can be reimbursed separately with substantiation.

Tax Consequences of Non-Compliance

If a reimbursement arrangement fails to meet any of the three conditions for an accountable plan, it is classified as a “non-accountable plan.” Under this classification, all reimbursements are treated as taxable wages, removing the tax-free benefit for the employee.

For the employee, the reimbursement amount is added to their gross income and reported as wages in Box 1 of their Form W-2. This increases the employee’s total taxable income, which can lead to a higher tax liability and potentially push them into a higher tax bracket.

For the employer, these reimbursements are considered wages and are subject to payroll taxes. The employer must withhold federal income, Social Security, and Medicare taxes from the payment, just as they would from a regular paycheck. The company is also responsible for paying its share of Social Security and Medicare taxes on the amount, increasing its payroll tax expense.