Employee Expense Reimbursement & Employer Tax Implications
Employee expense reimbursement can be a contentious topic for business owners and their employees. While business owners may have clear ideas about which expenses they should cover, employees who pay for business-related items out of pocket will also expect to be paid back promptly and in full.
How you choose to reimburse your employees has tax implications for your company as well as for employees. Working with a tax professional can help your business reduce unnecessary costs and get the most out of its tax return.
What Is Employee Expense Reimbursement?
It's common for employees to run up business expenses in many different contexts. When employees spend their own money on business-related expenses, they usually expect their employer to reimburse them. Some typical examples of employee expenses include:
Expenses incurred while on business trips, such as transportation, lodging, and meals
Meals and/or entertainment in certain contexts
Business use of the employee's personal vehicle
Tools and other work supplies purchased by the employee
Uniform purchase and laundering costs
Professional dues, licenses, and expenses related to required continuing education
Consult the official IRS guidelines regarding business expenses for more detailed information on the expenses that might be eligible for reimbursement.
The Importance of a Company-Wide Expense Reimbursement Policy
Because some of these expenses can be subject to interpretation, creating a clear and fair policy regarding employee reimbursements protects both the employer and the employees. A reimbursement policy tells employees what qualifies for expense reimbursements and how (and when) to request a reimbursement.
A company-wide policy also reduces the need to review and approve each reimbursement request before the transaction can be completed. In your policy, establish the types of expenses that will be refunded, any limits, and the procedure for claiming reimbursement. For example, you might request expense reports and establish a paper or digital system for collating receipts.
Accountable vs Non-Accountable Reimbursement Plans
To ensure that employee expense reimbursements are regulated and fair across the board, companies often create formal reimbursement plans. A reimbursement plan can be either accountable or non-accountable.
Option 1: Accountable Plans
An accountable plan sets down clear rules regarding how employees claim reimbursable expenses. This tends to establish a time limit—this could be up to 60 days, for example—within which employees must justify their expenses and provide a receipt for reimbursement.
An accountable plan will explain how the employee should refund the company any excess advances, and the time limit the employee has to do so. The plan can also stipulate when a company needs to make advances; this could be within a period of 30 days before the expected expense.
Does the IRS Require an Accountable Plan?
The IRS doesn't mandate accountable plans. However, accountable plans help your business distinguish between deductible reimbursement expenses and those that may need to be taxed.
Option 2: Non-Accountable Plans
A non-accountable plan is one that doesn't satisfy the requirements of an accountable plan. Employees are typically given an allowance for business-related expenses and can pocket whatever they don’t spend. Accordingly, any allowances that an employer pays are considered a supplement to regular wages and therefore are subject to taxation.
Example of a Non-Accountable Plan
An employee who has travel expenses on a business trip to Jacksonville, Florida may be given a daily $75 stipend for meals and other expenses. In this case, the employee isn't subject to any limits under the employee expense reimbursement policy as they don't need to provide receipts for their expenses. In addition, the employee doesn't need to return the difference between what they spend and the $75 allowance. The stipend will be counted as supplemental income and taxed accordingly.
What Are the Legal Implications of Having an Expense Reimbursement Policy?
The Fair Labor Standards Act (FLSA) states that employers don't have an obligation to reimburse employees for business expenses. However, this comes with some caveats:
Business expenses can't reduce employees' wages below minimum wage or decrease their overtime compensation.
Laws regarding reimbursement obligations may differ from state to state.
Some types of reimbursed business-related expenses may count as taxable income.
How to Reimburse Business Expenses
It's important to verify all expenses before reimbursing the employee. Depending on the type of expense, you can track and reimburse expenses in different ways:
Mileage: Employees can submit a manual travel log or use a mobile app to track their business miles. Use the updated IRS standard mileage rate to calculate the applicable reimbursement amount.
Travel expenses: Employees should keep all receipts related to business trips and request reimbursement for the exact amount. They can also scan receipts into an app and log the amounts digitally to prevent problems with lost, damaged, or forgotten receipts.
Once the employee has provided documentation to back up their reimbursement request, there are different ways to process it. While in some businesses employees submit reimbursement requests manually, other companies may find reimbursing employees and expense management a lot easier if they use an app or another digital reporting method. The reimbursement amount is then generally paid by direct deposit, either separately or together with payroll.
Consider Employee Credit Cards
To sidestep the arduous process of reimbursement, some companies issue employees with a company credit card. Though it's still necessary to review payments, it can streamline the process both for the employee and the accounting department as the employee never has to pay for anything out of pocket.
What Are the Tax Implications for Reimbursements?
The question of whether reimbursements are subject to tax depends on whether you choose an accountable or non-accountable plan. IRS reporting requirements are based on these models.
Expenses covered under a non-accountable plan are considered income and must be included in the employee's W-2.
Non-accountable plan expenses are also subject to employment taxes. This includes tax withholding, FICA, and state and federal unemployment taxes.
Accountable plans create more paperwork for employers, but the business avoids payroll taxes on the reimbursement amounts.
When choosing a plan, employers should consider the tax implications for the employee. An accountable plan allows employees to receive expense reimbursements without paying any personal income tax on these amounts. However, a non-accountable plan increases the amount of gross income reported to the employee.
It may not always be clear how your reimbursement plan will affect your business and your employees. That's why hiring a tax professional is important.
Benefits that Are Subject to Taxation
There are a few business-related benefits that are generally taxable for the employee:
Using a company car for personal use: Employees will need to pay tax on the percentage of time the vehicle is used for personal use.
Rewards: Employees who receive prizes or rewards via goods or services—for example a trip as a reward for meeting sales targets—should report the market value of the prize.
Services: Employees who receive employer-related services like accounting via their company should declare the value of those services as part of their salary.
Employers and employees should consult a tax professional to find out how these benefits should be reported on their tax returns.
Non-Taxable Employee Reimbursements
Though the following reimbursements are generally non-taxable, consult a tax planning professional to make sure you’re fulfilling your obligations to the IRS. Some examples of non-taxable reimbursements include:
Eligible employee reimbursements under an accountable plan
Reimbursements related to education up to $5,250. You will pay tax on the amount over $5,250.
Some insurance premiums
Meals or lodging provided on work sites (with some limitations)
Using a company van for commuting purposes,in certain situations
Because non-taxable reimbursements aren't limited to these examples, ask a tax professional how you can take advantage of all the deductions possible.
Recent Changes to Employee Business Expenses Rules
As a business owner, you should understand the changes brought about by the Tax Cuts and Jobs Act. This act changed several regulations regarding depreciation, deductions, fringe benefits and new credit, and business structure and accounting methods.
Regarding expenses, changes include variations on how much you can deduct for business meals or entertainment, employee rewards and prizes, plus other significant changes that may affect your business.
Working with a tax professional helps your business stay on top of all changes in the law. This means you won't let potential deductions slip through the net or try to claim a deduction that is no longer applicable.
Consult a Tax Professional to Maximize Your Tax Benefits
Employee expense reimbursements provide an avenue for covering employees’ out-of-pocket business-related expenditures after the Tax Cuts and Jobs Act removed the option for employees to claim these expenses as deductions on their tax returns. Reimbursements made under accountable plans are tax-free for both the employer and the employee, whereas allowances given under non-accountable plans are considered taxable income and must be declared.
When setting up a reimbursement policy for your business, it’s important to consult a tax professional. He or she can explain the ins and outs of accountable and non-accountable plans and help you set up a system that’s both fair and has the most favorable tax outcomes for your business and its employees.
