Sometimes, an employee might pay for a business expense out of their own pocket. When that happens, you can reimburse the employee.
An employee expense reimbursement does come with some complications. Are reimbursements taxable? Do you need to report the reimbursement? Find out below.
What are expense reimbursements?
Reimbursements are a way for you to pay employees back when they spend their own money on business expenses.
Let’s say an employee is driving the company vehicle between client meetings. They stop to refill the gas tank. The employee pays for the gas themselves and asks you for a reimbursement when they return to the business.
Expense reimbursements are common when employees travel for work. They might need to pay for meals, lodging, gas, and entertaining clients.
Are reimbursements taxable?
When you give money to an employee, you typically have to withhold and contribute taxes on the payment. So, are reimbursed expenses taxable? Well, it depends. The IRS expense reimbursement guidelines have two types of plans: accountable and nonaccountable. Whether or not you must withhold taxes depends on the plan used by your business.
You can learn more about expense reimbursements in Publication 15.
If your business uses an accountable plan, reimbursements are not taxable. You do not have to withhold or contribute income, FICA, or unemployment taxes.
To have an accountable plan, your employees must meet all three of the following rules:
- The employee must have incurred deductible expenses while performing services as your employee. The reimbursement must be a payment for the expense. The reimbursement must not be an amount that would have otherwise been paid to the employee as wages.
- The employee must substantiate the amount, time, place, and purpose for the expenses to you within a reasonable period of time.
- The employee must return any amount in excess of the substantiated expense. The employee should return the excess within a reasonable amount of time.
What are reasonable amounts of time for the accountable plan? According to the IRS, it is reasonable for you to reimburse employees within 30 days of when they incur the expense. It is reasonable for employees to account for their expenses within 60 days after they incur the expense. Employees should return excess amounts within 120 days of when the expense was incurred.
If your business uses an accountable plan but an employee fails to follow the plan, the expense reimbursement is taxable. For example, if an employee does not return excess amounts within a reasonable amount of time, the excess amounts are taxable.
Because reimbursements under the accountable plan are not wages and are not taxed, you do not have to report the amount. Do not include the amount with the employee’s wages on Form W-2. Instead, report it in Form W-2 box 12 with code L.
If your business uses a nonaccountable plan, you must pay tax on reimbursement of expenses. They are subject to all income, FICA, and unemployment taxes.
You have a nonaccountable plan if:
- The employee doesn’t have to substantiate expenses in a timely manner.
- The employee isn’t required to return excess amounts within a certain amount of time.
- You pay an amount regardless of whether you expect the employee to have a business expense.
- You pay an amount you would otherwise pay as wages.
Reimbursements under a nonaccountable plan are wages and are subject to taxes. You must report these wages and deposit taxes on them. Include the reimbursements and taxes on the employee’s Form W-2.
You might reimburse an employee with a per diem rate. Per diem pay is used to reimburse mileage, meals, lodging, and some other fixed allowances.
With per diem payments, the IRS says your employee accounted to you if the reimbursement does not exceed the established per diem rates.
You should include per diem payments in box 12 of Form W-2 using code L.
If your per diem payment exceeds the preset rates, the excess amount is considered wages. You must withhold and contribute taxes on the excess amount. Include the excess per diem amount and taxes on Form W-2.
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This article has been updated from its original publication date of November 22, 2017.This is not intended as legal advice; for more information, please click here.