Employee Expense Reimbursement 101: What Should Businesses Know?
Employee expense reimbursement is an area that's sometimes overlooked by business owners. Employees who spend their own money on job-related items often request to be reimbursed for these expenses. In such cases, what should a business cover, and how should reimbursement be handled?
What Is Employee Expense Reimbursement?
In the course of business, it's common practice for employers to reimburse their employees for certain business expenses. Some examples include:
- Business travel
- Meals and entertainment
- Business use of a personal vehicle
- Tools and supplies
- Education expenses and professional dues
Rather than reviewing and repaying employees as individual expenses are incurred, your company should consider creating a policy for employee reimbursement that sets expectations about how and when a request will qualify. An employee expense reimbursement policy should define which expenses will be reimbursed and offer information on how to go about receiving funds, via an online form or the submission of receipts.
A well-designed policy will also help maximize tax benefits related to expense reimbursement for both employee and employer.
Accountable vs. Non-Accountable Reimbursement Plans
To curb unregulated reimbursement of employee expenses, companies often establish formal policies that address this particular issue. Generally speaking, companies can cover employees' expenses in two ways: through an accountable plan or a non-accountable plan.
An accountable plan is a reimbursement arrangement that requires employees to substantiate their business-related expenses to the company within a reasonable timeframe (no more than 60 days from the date of the expense). The accountable reimbursement plan also sets out how to refund the company any excess advances within a reasonable period (no more than 120 days from the date of incurring or paying the expense); no advances can be made more than 30 days prior to the time of the expense.
The IRS does not mandate accountable plans, but having such a plan in place enables your business to conform to IRS regulations concerning deductible reimbursements and reimbursements that are judged taxable income.
A non-accountable expense reimbursement plan is one that does not satisfy the requirements of an accountable plan. Any form of non-accountable allowance arrangement is considered supplemental wages that are subject to taxation. Non-accountable plans may include provisions that disqualify:
- Employees who fail to submit and justify expenses in a set period of time; and
- Employees who don't meet an agreed-upon deadline to return excess allowances or reimbursements.
For example, an employer may provide an employee with a set amount for expenses while traveling on business. Assume the reimbursement plan provides $75 per day for meals and the employee does not need to provide receipts for expenses. The employee is also not required to return the difference between what they actually spend and the $75 allowance. This would be an example of a non-accountable plan.
The assumption in this case is that the employee typically will not spend the full allowance and therefore is receiving some form of payment for services. When employees are reimbursed under a non-accountable plan, the payments will be included as taxable income, but may be deductible as an itemized deduction on their personal income tax return. In the example above, the full $75 allowance will be included in the employee's gross income and the actual expenses incurred will be included as an itemized deduction for employee business expense, subject to personal income tax limitations.
Do Employers Need To Have an Expense Reimbursement Policy?
Under the Fair Labor Standards Act (FLSA), employers are not required to reimburse employees for business expenses. However, such expenses may not reduce non-exempt employees' wages below the minimum wage, nor decrease their overtime compensation (state law may require employees to be reimbursed for business expenses). Depending on what type of expense is reimbursed, the amounts received may count as taxable income.
What Expenses Should a Business Cover?
Although employers may not be required to cover certain expenses incurred by employees, it's still customary to do so. If an employee spends money on the company's behalf, they may do so with the expectation that they will be reimbursed.
For this reason, a clear policy can help define your company's practice. When writing the policy, you should understand what is an allowable business expense, which can be defined as necessary to the operation of the business, and then decide how they will be paid for and reimbursed.
What are reimbursable expenses? Some of the most common employee expenses are related to:
- Business-related travel. Airfare, train, and/or other transportation expenses should be reimbursed to employees.
- Meals. Employees should also be reimbursed for meals as part of travel or business-related activities. Often, businesses impose a limit on meal expenses, keeping them within a reasonable range. Per-diem arrangements may be considered, eliminating the need for employees to submit meal receipts.
- Smartphones. As the need increases for extended accessibility to calls, voicemail, and emails, smartphone plans are another commonly reimbursable expense.
- Accommodations for travel. Lodging costs incurred as part of business-related travel are usually regarded as reimbursement expenses. Again, a per-diem arrangement may be preferable to employees submitting receipts.
- Training. Costs relating to employee training and development also fall under the umbrella of reimbursable expenses.
As should be clear, small businesses customarily reimburse certain employee expenses incurred in connection with assigned job functions.
Reimbursing Business Expenses
Any business expense should be substantiated before an employee is reimbursed. In the case of mileage, a travel log prepared by the employee is acceptable. For ease of tracking, you can ask employees to use a mobile app to input all business-related expenses for reimbursement. Receipts can be scanned and saved to reduce paperwork.
To avoid the need for reimbursement, some employers consider giving employees who purchase items on a regular basis a business credit card. In these cases, it's considered a best practice to maintain separation of duties, and all credit card purchases should be reviewed and paid by someone other than the purchaser.
Are Reimbursements Taxable?
Paying wages to employees always involves withholding and contributing taxes, but with reimbursements it all revolves around accountable and non-accountable plans. That's because IRS reporting requirements are built around these two types of plans.
Business expenses reimbursed under a non-accountable plan are considered income to the employee and must be included as such in the employee's W-2. This type of reimbursement is also subject to employment taxes both for the employee and employer that can include withholding taxes, FICA, and federal and state unemployment taxes.
Employers may consider the additional paperwork a disadvantage to adopting an accountable plan, but an advantage that may offset this additional work is the avoidance of added payroll taxes under the non-accountable plan.
Employers may also consider how employees will perceive reimbursements under each type of plan. The accountable plan allows employees to receive reimbursements without any personal income tax effects. The non-accountable plan increases gross income reported to the employee, with the option to deduct the business expenses personally. As itemized deductions, the expenses may or may not be deductible depending on the employee's individual tax situation.
Employers should consider the advantages and disadvantages to each type of plan in deciding how to structure the reimbursement of employee business expenses.
Taxable Reimbursements and Payments
There are a number of reimbursable business expenses that are generally taxable for the employee:
- Personal use of a company car. If you provide your employees with a vehicle for business and an employee uses it for personal reasons, part of the associated expense may be subject to taxation.
- Trips and prizes. Prizes that are given in the form of goods or services must be reported with an employee's income for their fair market value. An example of this might be a performance-related trip for employees who meet their sales goals.
- Services. If your company provides employer-related services such as accounting or legal advising, the value of those services should be reported as salary or wages.
Generally Non-Taxable Employee Reimbursements
The following reimbursements are generally non-taxable. Many categories, however, have specific guidelines that govern their taxability, so it's important to consult appropriate resources before proceeding:
- Approved employee business reimbursements that conform to IRS expense reimbursement guidelines
- Educational reimbursements up to a maximum $5,250 per year
- Specific insurance premiums including: up to $50,000 in group life insurance coverage, accident and health benefits, and the employer's share of COBRA contributions
- Gifts with a minimal value or awards such as plaques and trophies
- Discounts of up to 20% on employer-provided goods or services
- Retirement planning services offered as part of a qualified retirement plan
- Meals or lodging provided on the work site, if specific guidelines are met
- Using a company van for commuting, provided specific guidelines are met
- Up to $280 per month worth of transportation-related fringe benefits such as free parking, van pooling, or transit passes.
Employee Expenses Eligible for Tax Write-Offs
Employee expenses deemed necessary to their job can be deducted for tax purposes, regardless if they are reimbursed. Common examples include:
- Required tools and equipment. Some employers require employees to purchase items that are considered primarily for the benefit or convenience of the employer (tools used in the employee's work, for example). Under the FLSA, non-exempt employees may not be required to pay for any of the cost of such items if, by so doing, their wages would be reduced below the required minimum wage or overtime compensation. Again, state law may differ.
- Uniforms. If an employer requires employees to wear a uniform, the cost and maintenance of the uniform is considered a business expense of the employer. If the employer requires the employee to bear the cost, it may not reduce the employee's wage below the minimum wage or cut into overtime compensation as outlined by the FLSA.
Maximizing Reimbursement-Related Tax Benefits
Having clarity on the taxability of employee reimbursements is critical so that businesses can establish their withholding plans and employees can evaluate the final value of their compensation. To maximize the tax benefits related to employee reimbursement, companies may set up an accountable plan. Expenses detailed and reimbursed under this plan are not considered taxable income to employees and therefore not subject to payroll tax.
When choosing to reimburse expenses under a non-accountable plan, the amount employees are paid is considered income for tax purposes. Companies may use a combination of an accountable plan and a non-accountable plan if they wish to reimburse some expenses tax-free and others (such as per-diem meals) as taxable income. Additional guidance can be found by consulting a tax professional or by reviewing IRS Publication 535 — Business Expenses.
Independent Contractors and Including Expenses in the 1099
The use of independent contractors entails different reimbursement rules, chiefly as they are paid via Form 1099. Employers generally opt to include reimbursement payments on the 1099, as opposed to a straightforward process of reimbursing expenses. It's up to the independent contractor to do their own business expense deductions when completing their own tax filings.
Setting Spending Limits and Reimbursement Caps
Spending limits allow for proper budgeting and help guide employees as to the types of acceptable expenses. Limits can be capped on a per-diem rate or an annual amount, such as tuition reimbursement for a certain number of classes. In some cases, current tax law or government standards can be used to set limits.
If employees travel as part of their job, the company can use certain government-set rates to reimburse travel costs. Many employers reimburse employees for their business driving, for example. If the reimbursement is done under an accountable plan up to the IRS standard mileage rate, there is no taxable compensation reportable to employees or subject to payroll taxes. The mileage rate for 2022 is 58.5 cents per mile (up from 56.0 cents in 2021).
In general, reimbursements for moving expenses are no longer excludable from gross income for the employee or deductible by the company. They are now a taxable fringe benefit subject to payroll taxes.
Other common employee reimbursements where spending limits are added include:
Out-of-town meals. These can be capped via a daily per-diem rate, which would allow employees the discretion of how much to spend on each individual meal. Extra meal costs above the per diem would be out of pocket for the employee. The U.S. General Services Administration (GSA) sets per diem rates that give small employers a guide to reasonable amounts per geographic region.
Tuition reimbursement. This can be limited to a certain number of classes or a dollar amount each year.
Car expenses. Various approaches can include the use of a set vehicle allowance versus reimbursing actual mileage or a combination of both. There are tax differences in these methods that you should carefully assess prior to selecting one or the other.
Cell phone expenses. These expenses, when required for one's job, can also be reimbursed by employers. Provide employees with a company cell phone, or allow them to select and pay for their own cell phone and be reimbursed. The company may opt to reimburse a set amount to each individual that would equal a common company plan.
An important part of your company's financial policy is to clarify what items may be subject to taxation when and if reimbursements occur. The IRS provides guidance on employee expenses in guidelines such as Topic 463: Travel, Entertainment, Gift, and Car Expenses.
Setting an Expense Reimbursement Policy
The key to successful employee expense reimbursement is to have a documented policy defining reimbursable expenses and stipulating how they will be repaid. As your company grows and the number of employee expense reimbursement requests increases, adopting a leading expense management solution may help increase reimbursement efficiency and policy enforcement.