Are Employee Reimbursements Taxable?
It’s inevitable that your employees will pay for business expenses with their own money and ask for reimbursement. You’ll want to reimburse your employees quickly but also do it correctly.
Your business should have a written expense reimbursement policy that is shared with employees. The policy should include things like what types of expenses are reimbursable, how to submit and document expenses, and when expenses will be reimbursed.
You’ll need to know whether reimbursements are taxable. Whether or not reimbursements are taxable is partly based on how the reimbursement policy is structured. Your policy can be classified as an accountable plan or a nonaccountable plan.
Accountable reimbursement plans require employees to account for reimbursable expenses. That means they must provide proof of the expense. That could be a receipt or a paid invoice. And it could also be a mileage log for a vehicle.
Expenses reimbursed under an accountable plan are not taxable to the employee.
To be an accountable plan, the IRS requires it to meet three criteria.
- Expenses must have a business purpose.
- Expenses must be reported to the company in a reasonable time.
- Any excess reimbursement must be returned to the company in a timely manner .
Although you may have a written policy that meets the three criteria, if you don’t follow your policy, it can create taxable income to employees.
For example, if an expense is reimbursed that isn’t for business purpose, isn’t reported in a timely manner, or an excess reimbursement isn’t returned timely, then that particular expense will be deemed to be made under a nonaccountable plan and becomes taxable to the employee.
If your written policy doesn’t meet the IRS’s requirements or if you reimburse expenses that don’t meet the requirements, it’s deemed nonaccountable and those are taxable to employees.
If you make a nonaccountable reimbursement, you’ll need to include the amount in the employee’s taxable wages and that will cost you and your employee.
This means you’ll have to withhold federal and state (if applicable) income taxes and FICA and you’ll have to pay FICA, FUTA, and SUTA.
The gross reimbursement amount will be included in Box 1 on the employee’s W-2 and any taxes withheld will also be shown.
Now that we know when reimbursements are taxable, let’s go through the common types of employee reimbursements and discuss their tax consequences.
When an employee travels for business and incurs expenses, you’ll want to reimburse them. Travel expenses include airfare, lodging, and transportation costs for things like taxis or trains.
Your employee should complete an expense reimbursement form and have it approved by his or her manager. There is electronic expense tracking software that can help. Expenses are tracked in the software and scanned images of receipts are attached. This can reduce the need to print and store expense reports and helps for remote based employees.
All expenses should be submitted with a receipt. If no receipt is provided, then it’s considered a nonaccountable expense and taxable.
In the event an employee loses a receipt, you could have them complete a lost receipt form that requires them to document the expense.
Employees may purchase meals when traveling, when meeting with a client, or for an office wide meeting. Although any meal paid for by an employee should be 100% reimbursed by the company, the nature of the meal will determine whether your business can receive a tax deduction of 100%, 50%, or none of the cost.
100% Meal Deduction
The general rule is that meal reimbursements are only 50% deductible for tax purposes.
But there are a few exceptions that allow for 100% deductibility. To be 100% deductible, the meal must meet one of the following criteria:
- Provided to all employees for social or recreational activities. Things like company picnics, office snacks, or holiday parties would qualify for 100% deductibility.
- Provided by law to employees on certain commercial vessels and certain oil platforms.
- Included in an employee’s compensation.
- Reimbursed to the company from an outside party.
50% Meal Deduction
Most meals will qualify for the 50% deduction for tax purposes so long as they are for business purposes and are substantiated with receipts. Common examples include:
- Lunch or dinner with a client.
- Meals incurred during business travel.
- Meals for office meetings.
- Meals while attending a conference or seminar.
If a business meal is eaten in combination with some type of entertainment, the general rule is that none of the meal is deductible. That’s thanks to the 2017 passage of the Tax Cuts and Jobs Act which eliminated the tax deduction for entertainment expenses.
However, if the cost of the meal can be separated from the cost of the entertainment and shown separately on a receipt or invoice, then the meal will qualify for the 50% deduction. But none of the entertainment cost is deductible.
For example, you bought tickets three months ago to take a client to a hockey game. Before the game begins, you and the client have dinner at a restaurant inside the hockey arena. Since the cost of the meal is separate from the cost of the tickets, the meal is 50% deductible.
If, however, the tickets you bought included a large pizza and two beers, then the meal wouldn’t be deductible since its cost can’t be separated from the cost of the tickets.
As mentioned above, since 2018, entertainment expenses are no longer tax deductible. Previously, they were 50% deductible.
Examples of entertainment expenses include:
- Tickets to sporting events, music, or other theatrical performances.
- Activities at a nightclub, bar, or lounge.
- Golf course memberships or fees.
- Travel that primarily benefits an owner or employee.
Oftentimes as a perk or benefit, an employer will provide some type of reimbursement for employee parking or public transit fees. Although you can still provide this benefit to employees, you’ll no longer be able to claim the expense as a tax deduction.
Like entertainment expenses discussed above, since the passage of the Tax Cuts and Jobs Act in December 2017, a business can no longer deduct the cost of commuter benefits provided to an employee.
Another benefit some employers offer is reimbursement of certain employee education expenses. The cost of tuition, books, and school fees are often included in these programs.
These educational assistance programs can’t discriminate in favor of higher income earners or owners and officers. Further, for employees not enrolled in school, the program can’t allow employees to choose some other form of payment.
For example, if an employee is taking college courses to complete a degree and your company reimburses for tuition costs, you’ll be able to deduct the entire reimbursement amount from your business tax return.
There are limits to how much you can reimburse employees. If you reimburse an employee more than $5,250 in a year for education expenses, the excess becomes taxable to the employee.
The CARES Act passed in April 2020 allows employers to include student loan payments in its educational assistance program. That means that employers can pay up to $5,250 toward student loans of their employees. You’ll have to act quickly because this inclusion is only good through December 31, 2020 unless Congress intervenes. After that, any payments an employer makes towards student loans of its employees is taxable to the employee.
For 2018 – 2025, if you reimburse an employee for moving expenses so they can relocate to join your company, that reimbursement is taxable to the employee. This also includes moving allowances you give without requiring the employee to account for expenses.
And starting in 2026, moving expense reimbursements and allowances will be excluded from taxable income of your employee.
As an employer, you’ll be able to deduct the expense reimbursement from your taxes so long as the employee provided you with proper documentation to meet the accountable plan requirements.
How to Reimburse
You’ll want to reimburse your employees timely for expenses they incur.
Maybe you’ll do it once a week on Fridays. Anyone who submitted an approved expense report during the week would receive their reimbursement at the end of the week. Or you could schedule it to align with pay day.
Best practices would suggest not waiting more than two weeks to reimburse employees.
To avoid confusion, it is best to pay expenses separate from payroll to avoid miscoding a non-taxable expense reimbursement. Instead make expense reimbursements a part of your payables process and cut employees a separate check.
Finally, unless the reimbursement is a small amount, avoid paying with cash. You’ll want the audit trail of paying back employees with a check or other trackable method.
None of this information should be taken as legal or financial advice, nor should it deter you from seeking the assistance of a licensed attorney, accountant, or financial services professional. It is meant strictly for educational use so you can design your expense reimbursement policy with ease.