Small businesses pay 21% in federal taxes, and 44 states tack another 4-9% on top of that. That’s a significant portion of your small business revenue, and equates to hours of accounting to get it right.
We’re covering one of the more complicated elements of small business taxes—employee reimbursements. This guide will help you determine if employee reimbursements count as taxable income and how to record them.
What are employee reimbursements?
Throughout the regular course of work, employees will occasionally need to pay for business expenses with their own money. Whether it’s gas, meals, mileage, client entertainment, or an Uber, employees will need to be paid back for expenses incurred during business operations.
Even when employee reimbursements are rare, it’s a good idea for companies to establish a reimbursement policy to ensure that employee expenses are reasonable, recorded, and paid back in a timely manner.
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Are employee reimbursements taxable?
Taxes for small businesses can be complex, so it’s important to track each and every business expense properly. No one wants to be surprised when tax season rolls around, finding that they owe more than expected or that they lack the proper documentation for exemptions they’ve earned.
Generally payments made to employees are subject to taxes, so the employer will withhold and then contribute those taxes on behalf of the employee (read more about your tax responsibilities as an employer in the Publication 15 of the IRS).
Reimbursements are handled a little differently, though, and the taxes in question are determined by the type of plan you use: accountable or non-accountable.
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What is an accountable plan?
The most common choice for employers is an accountable plan. An accountable plan is not taxable, as long as it follows these specific guidelines:
- The reimbursement is for expenses incurred for company purposes.
- The expense was documented in a reasonable amount of time, with identifying information such as amount, time, place, and purpose for the purchase.
- Any excess reimbursement is returned to the employer in a reasonable amount of time.
What is a “reasonable amount of time”?
According to the IRS, here are the timeframes for reimbursable expenses:
- Employees need to document expenses within 60 days of purchase
- Employers need to issue an expense reimbursement within 30 days of purchase or documentation of purchase
- Excess reimbursements need to be returned within 120 days
As long as these rules are followed, you will not need to pay taxes on employee reimbursements. However, if an employee fails to follow the rules then taxes will need to be withheld. For example, if the business expense isn’t reported in a timely manner or if excess isn’t returned then taxes will need to be withheld and contributed for the expense total.
Under an accountable plan you don’t need to record these reimbursements as taxable wages—you’ll just record them in box 12 of the W-2 form.
What is a non-accountable plan?
A non-accountable plan is utilized when expenses aren’t conducive to an accountable plan, and will therefore be subject to taxes. Non-accountable plan reimbursements will require paying income taxes, FICA taxes, and unemployment taxes.
A non-accountable plan would include:
- Expenses that don’t need to be reported
- Allowances or budgets that don’t need to be returned
- Reimbursements that would otherwise be wages
Essentially reimbursements under a non-accountable plan are wages, and need to be recorded on the employee’s W-2.
What are some examples of employee reimbursements?
To showcase how employee reimbursements are taxed in practice, let’s look at some of the most common examples of employee expense reimbursements.
Business meal reimbursements
Business meal reimbursements are tricky to navigate because they must be proven to be for business purposes as part of an accountable plan. Doing so requires documentation of who was there and what was discussed.
To do this, the employee must provide a receipt and information on who was there and the purpose of the business meal. Maybe it was discussing new sales tactics or hosting a potential client to talk through a new deal.
If it’s sufficiently documented, business meal reimbursements are non-taxable under an accountable plan.
Travel reimbursements
Similar to business meals, travel reimbursements are non-taxable if the purpose is sufficiently documented and receipts are provided.
In addition to the receipts, keep a record of where the employee traveled to and what they were doing there (including who was visited or what event was intended if applicable).
In some cases, employees are provided a travel per diem instead of having their expenses directly reimbursed—more on that later.
Business mileage reimbursements
If an employee uses a personal vehicle for business purposes, they can be reimbursed based on the mileage driven. In this case, the business sets a per mile reimbursement rate (often using the IRS standard mileage rate).
For these reimbursements to be non-taxable, the employee must log the mileage and purpose of any work-related trips. The mileage log should include the:
- Date of the trip
- Business-related destination
- Purpose of the trip
- Mileage driven (best if supported by odometer photos)
Cellphone reimbursements
Reimbursing an employee for a cellphone plan requires some additional work to prove usage for business purposes.
To keep the reimbursement tax-free, the cellphone plan needs to be proven to be for work-related use. If it’s a personal plan that will be partially reimbursed, work must be put in to prove a percentage of work-related use.
For example, if the cellphone plan is for $50 and the business is reimbursing $25, it must prove that at least 50% of the plan usage is for business purposes. There’s no specific way to do so, but you must demonstrate the reasoning of the percentage being reimbursed.
While not mandated, a log of work-related calls or usage helps in proving the expense in the case of an audit.
How do I tax per diem reimbursements?
If your business requires travel regularly, it may make more sense to allow per diem expenses. A per diem is a daily allowance for food, mileage, hotels, taxis, and other expenses that may be incurred when an employee is required to travel for work purposes.
The current per diem allowance for the continental U.S. in non high-cost localities is $151 per day. Check the GSA per diem rates for updated and localized rates.
Per diem payments are not subject to taxes, so long as they stay below the prescribed per diem rate. Anything spent over that rate and reimbursed by the company will need to be reported as wages and taxed accordingly.
Frequently asked questions
Are moving expenses taxable?
Yes, moving expenses are counted as taxable income, whether it’s a relocation bonus, moving allowance, or moving expenses paid directly by the company. The employee will be taxed for these additional amounts as if they were wages or income.
What are fringe benefits and are they taxable?
Fringe benefits are additions to the general compensation expected by employees, which help to attract and maintain talent. Common fringe benefits would include health insurance, life insurance, snacks or meals in the workplace, employee discounts, stock options, company cars, or child care. Generally, fringe benefits are exempt from taxes so long as they stay under acceptable limits as outlined by the IRS Publication 15-B regarding fringe benefits.
Are medical expense reimbursements and health insurance taxable?
Medical expense reimbursements are tax-free for employees, and tax-deductible for employers. Health insurance is not taxed for either employer or employee.
Do reimbursements show up on a W-2?
Form W-2 is filled out by employers to report an employee’s compensation as well as deductions taken from their pay for Social Security or Medicare.
If reimbursements adhere to an accountable plan, they are not considered part of the employee’s compensation. Therefore the reimbursement is not reported on a W-2 form.
However, if the reimbursement is part of a non-accountable plan, it’s considered compensation and therefore must be reported on a W-2 form.
Should reimbursements be paid through payroll?
Whether a reimbursement should be paid through payroll depends on whether it’s part of an accountable plan or a non-accountable plan.
Reimbursements as part of an accountable plan are not taxed and should not be reimbursed through payroll. It’s best to keep these reimbursements separate both in payments and reporting.
Non-accountable plan reimbursements are taxed as wages and should be reported as and paid out as payroll.
Are reimbursements part of gross pay?
Reimbursements are not a part of gross pay if they are part of an accountable plan. They are reported separately and paid separately from an employee’s gross pay.
If a reimbursement is part of a non-accountable plan, they are paid out as taxed compensation. They are included in gross pay and are taxed as salaries and wages would be.
Save time with your reimbursement process
With a well-constructed reimbursement plan in place, most businesses can utilize an accountable plan and avoid taxing the reimbursements for business expenses. But even when taxation is necessary under your nonaccountable plan, it’s fairly easy to manage. We encourage you to analyze your employee expenses and expense reimbursement process to allow for quick and painless reimbursements.
