What Are Employee Expense Reimbursem*nts and Are They Taxable? - Justworks (2024)

Table of Contents

No matter whether a company is big or small, every business incurs costs and expenses that may reduce the business' taxable income. Sometimes, employees — not just employers — are the ones who incur business expenses. That’s where expense reimbursem*nt comes in.

Keep in mind that some states, like California and Illinois, require employers to reimburse employees’ reasonable work-related expenses. Make sure that you understand and follow the applicable laws in the states where you have employees.

What Is Employee Expense Reimbursem*nt?

The expense reimbursem*nt process allows employers to pay back employees who have spent their own money for business-related expenses. When employees receive an expense reimbursem*nt, typically they won’t be required to report such payments as wages or income.

These types of reimbursable expenses tend to occur when employees travel for work, but can be associated with other activities related to their employment, including, for example, certain purchases of work-related supplies or tools.

Are Business Expense Reimbursem*nts Taxable Income To The Employee?

Page 16 of IRSPublication 15, (Circular E), Employer's Tax Guide, states that expense reimbursem*nts do not have to be included in an employee's wages if the business has an “accountable” plan.

What Is an Accountable Plan for Reimbursing Employees?

An accountable plan is a plan under which allowances or reimbursem*nts paid to employees for business-related expenses are not counted as income and are not subject to withholding.

While they’re not required by the IRS, accountable plans help you set criteria that comply with IRS regulations on what reimbursem*nts are deductible and what reimbursem*nts count as taxable income.

An accountable plan for employee expenses acts as a guardrail for employees to avoid being taxed on employer reimbursem*nts.

How Do You Qualify For An Employee Expense Reimbursem*nt Plan?

In order to have an accountable reimbursem*nt plan, an expense reimbursem*nt policy or advance payment program must meet the following three conditions:

1. Business connection:The expense must occur in the performance of services as an employee of the employer.

2. Substantiation:The employeemust substantiate their business expensesby providing the employer with evidence of the amount, time, place, and business purpose of the expense. The employee also must submit business expenses within a reasonable period of time after they occurred.

3. Returning excess amounts:If any amounts the employer pays to the employee exceed the amounts the employee spent, the employee must return excess amounts to the employer within a reasonable period of time.

What Counts as Employee Business Expenses?

When an employer reimburses an employee pursuant to an accountable plan, the reimbursem*nt won’t count as wages or income to the employee. Often, an employer will be able to deduct those reimbursem*nts, but the deduction amount may be limited.

IRSPublication 535, Business Expenses, states the following: “To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your industry. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary.”

What are some examples of ordinary and necessary expenses that would require employer reimbursem*nt? The most common are work-related supplies, travel, meals, and entertainment.

Business Supplies

Supplies that an employee purchases for business purposes can be reimbursed at cost, provided that they are reimbursed pursuant to an accountable plan.

Travel Expenses

The cost of work-related travel, including transportation, lodging, meals, and entertainment that meet the criteria outlined in IRSPublication 463, Travel, Entertainment, Gift, and Car Expenses, are generally reimbursable expenses.

Many employers will reimburse an employee who uses their personal vehicle for business at a standard mileage rate. Generally, this won’t include commuting expenses between an employee’s home and workplace. The standard mileage rateis set by the IRS each year. (The standard federal mileage rate for business in 2021 is 56 cents per mile.)

Meals & Entertainment

Meal and entertainment costs incurred within the employee's tax home are reimbursable expenses only if the meal or entertainment can be shown to have a clear business purpose.

Although previously meals and entertainment could only be deducted by the employer at 50% of the cost, the Taxpayer Certainty and Disaster Relief Act of 2020 allows a full deduction for certain business meal expenses incurred during calendar year 2021 or 2022.

Implement an Accountable Reimbursem*nt Plan

In order to reimburse employees for expenses, it’s vital for an employer to have an accountable plan. If you're interested in learning more about creating an accountable expense plan, download your free copy of Business Expenses: A Beginner's Guide To Building A Plan to find the helpful advice you're looking for.

If an employer does not have an accountable plan in place, then IRS Publication 15 states: “Payments to your employee for travel and other necessary expenses of your business under a nonaccountable plan are wages and are treated as supplemental wages and subject to the withholding and payment of income, social security, Medicare, and FUTA taxes.”

So, are reimbursem*nts taxable? It depends on the situation. If the employer does not have an accountable plan, then any reimbursem*nts, even those that are ordinary and necessary, are taxable income. Consider drafting a plan — doing so will likely save everyone time, confusion, and stress.

Even with an accountable plan, there are some things to look out for. For instance, if the employer has an accountable plan, but the employee fails to properly substantiate the expenses within a reasonable time, or the employee fails to return excess advance payments, then any reimbursem*nts could become taxable income.

In addition, if any expenses are paid in excess of IRS limitations, then the excess is taxable income. For example, if an employer reimburses an employee for mileage at more than the standard mileage rate, then the excess is taxable income.

Comply with IRS’ Rules

Employees should only have to pay income taxes on the wages they earn and certaintaxable fringe benefits. Expenses incurred by employees in the course of business should be costs incurred by the employer, not by its employees.

If the employer establishes a written accountable plan, and the employees submit properly documented expenses under that plan, then the reimbursem*nts shouldn’t count as taxable income.

However, a key to maintaining any accountable plan is to properly and timely substantiate expenses. Having a business accountant and referring to employment counsel are two ways for businesses to ensure they’re deducting and reporting the right expenses.

Justworks PEO Can Help

Customers of Justworks PEO can get support by using Expenses, our expense management tool that helps to streamline expense reimbursem*nt requests alongside payroll. Instead of using spreadsheets and email, businesses can use Expenses to consolidate tools and financial data, saving time for everyone at the company. Learn more about Expenses and our other payroll features.

PEOHealth InsuranceBenefits & PerksPayroll & TaxesExpenses & FinanceEmployment Laws

Written By

Moses Balian

Jul 28, 2023 • 4 minutes

Moses provides HR guidance and solutions that are tailored to the needs of Justworks' customers -- many of whom experience rapid growth and encounter the numerous challenges associated with starting a business.