What Is a Reimbursement and How Do They Work?
Demystify reimbursements: understand what they are, how to claim them, and their tax treatment for effective financial management.
A reimbursement involves receiving payment for money previously spent out-of-pocket. This process ensures individuals are made financially whole after covering costs that were not their primary responsibility.
Understanding Reimbursement Basics
A reimbursement restores an individual’s financial position after they have used their own funds for an expense that an employer, insurer, or other party is ultimately responsible for covering. This is a repayment of funds already expended.
The purpose of a reimbursement is to prevent individuals from bearing the financial burden of costs associated with their work, healthcare, or other predefined obligations of a third party. The process requires documentation to verify the expense and its legitimacy.
Common Reimbursable Expenses
Business travel expenses are frequently reimbursed, encompassing costs such as mileage for personal vehicle use, airfare, train tickets, lodging, and meals consumed while on business travel away from home.
Office supplies and other work-related materials purchased by an employee are also often eligible for reimbursement. This can include items like pens, paper, printer ink, or even specialized software licenses necessary for job performance.
Medical expenses that are out-of-pocket, such as deductibles, co-payments, or costs for services not fully covered by insurance, can be subject to reimbursement from health savings accounts (HSAs) or flexible spending accounts (FSAs). Educational expenses, particularly those for professional development or certifications directly related to an individual’s job, may also be reimbursed by an employer. These reimbursements support ongoing professional growth and compliance.
The Reimbursement Process
Initiating a reimbursement claim requires meticulous preparation of specific information and supporting documentation. For each expense, individuals must gather precise details including the date the expense was incurred, the exact amount spent, the business purpose or reason for the expenditure, and the vendor or merchant from whom the purchase was made.
Supporting documentation is also necessary to substantiate each claim, including original receipts, itemized invoices, or proof of payment such as credit card statements. This information is then often transcribed onto a designated reimbursement form, either physical or digital, ensuring all required fields are accurately completed before submission.
Once all preparatory information and documentation are assembled and the claim form is accurately filled, the procedural phase of submission begins. Claims are commonly submitted through an online portal or expense management system, which allows for digital upload of receipts and direct entry of expense details. Alternatively, physical forms and attached receipts may be mailed or delivered to a specific accounting or human resources department.
After submission, the claim undergoes a review period by the responsible party to verify its accuracy and adherence to established policies. This review takes a few business days, often between 3 to 10 days, depending on the volume and complexity of claims. Approved reimbursements are then processed for payment, commonly distributed via direct deposit into the individual’s bank account or through a mailed check.
Tax Implications
The tax treatment of reimbursements for the recipient largely depends on whether the payment falls under an “accountable plan” or a “non-accountable plan” as defined by the Internal Revenue Service (IRS). Under an accountable plan, reimbursements are not considered taxable income to the employee. For a plan to be accountable, expenses must have a business connection, be adequately substantiated with documentation within a reasonable time, and any excess reimbursement must be returned to the employer within a reasonable period.
Conversely, reimbursements made under a non-accountable plan are included in an employee’s gross income and are subject to income tax and employment taxes. A plan is considered non-accountable if it fails to meet any of the three criteria for an accountable plan. For instance, if an employee receives an allowance for expenses without being required to substantiate the costs or return any unspent portion, it would likely be treated as taxable wages. Understanding this distinction is important for individuals to properly assess their taxable income.