Employees who spend their own money on certain job-related items may request to be reimbursed for these expenses. Rather than reviewing and repaying employees as individual expenses are incurred, your company should create a policy for reimbursement to set 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.
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 is 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 to 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.
Some of the most common employee expenses are related to business travel and fringe benefits. The taxation of these expenses must also be understood to guarantee proper withholding. You should also review which employee business expenses are required to complete an individual's job duties. Employees who travel may fall under a meal reimbursement policy while those who work remotely may require a smart phone or laptop to access their email and work files. Employee benefit plans may also define reimbursable expenses such as adoption assistance, or tuition reimbursement.
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, and appropriate resources should be consulted before a final decision is made:
- Approved employee business reimbursements that conform to IRS 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 employer's share of COBRA contributions.
- Gifts with a minimal value or awards such as plaques and trophies.
- Discounts of up to 20 percent on employer-provided goods or services.
- Retirement planning services that are 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 $265 per month worth of transportation-related fringe benefits such as free parking, van pooling, or transit passes.
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 to reimburse employees, some employers consider giving employees who purchase items on a regular basis a business credit card. In these cases, it is 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.
Employee expenses eligible for 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 required 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 subjected 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 meal per diem) as taxable income. Additional guidance can be found by consulting a tax professional or by reviewing IRS Publication 535 - Business Expenses.
Setting spending limits
Spending limits allow for proper budgeting and help guide employees as to the types of expenses that are acceptable. 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. 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 2019 is 58 cents per mile (up from 54.5 cents in 2018).
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.
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.
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.