In business, employees may spend money on meals with clients, to buy supplies for an event, or on required certification courses. Many businesses choose to pay their employees back for these purchases through expense reimbursements.
Covering your employees' business-related expenses shows that you're taking care of them and don't expect them to pay for your business's growth out-of-pocket.
Let's dive deeper into what expense reimbursements are, why it's a good idea to provide them, and how they impact income and taxes.
What Is an Expense Reimbursement?
An expense reimbursement is a payment you make to an employee to repay them for a business-related expense.
For instance, say you have a sales manager who took a client out for a lunch meeting. The employee used their personal credit card to pay for that meal, and the total amount was $120.50 including tax and tip.
The amount you pay them back should be equal to what they paid in the first place. So, when you reimburse the employee, you should pay them the full $120.50.
What Are Examples of Expense Reimbursements?
Common types of expenses that businesses reimburse include:
- Business travel: Airfare, car rental, rideshares, taxis, and lodging costs for business trips.
- Meals and entertainment: Food, drinks, and activities related to client meetings or work outings.
- Personal vehicle used for business: Mileage-based reimbursements for employees that use a personal vehicle for business, such as field sales teams and inspectors. This doesn't usually apply to vehicles that are only used to commute to the office.
- Tools or supplies: Reimbursement for supplies and tools that have a business use. For example, if the employee restocks printer paper and ink using their own money.
- Education, certification, and professional dues: This can include continuing education and required memberships. For example, you might repay employees who have to continually renew their professional licenses to work for you.
- Remote office setup: Reimbursement for tools that enable the employee to work from home, which can include home internet, Zoom subscription, business phone, and office supplies.
Are Expense Reimbursements Taxable?
An expense reimbursement is not taxable if the expense was for business purposes, reported within 60 days with a receipt, and any excess reimbursement is paid back. We'll discuss this more later one, so keep reading!
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Should I Reimburse My Employees' Work-Related Expenses?
While there is no federal law requiring business owners to reimburse employees for work-related expenses, it's generally recommended that they do so anyway.
Think about it like this. Who would you rather work for? A company that pays you back if you buy a client's lunch or restock office supplies using your own money, or a company that expects you to pay for those things all on your own?
Legal Requirements for Reimbursing Employees
Here's a breakdown of the laws around reimbursing employees for business expenses:
- No federal law: There is no federal law that requires employers to reimburse employee expenses.
- Required if expenses impact minimum wage: However, according to the Fair Labor Standards Act (FLSA), non-exempt employees must not have work-related expenses that bring their total wages below the minimum wage or decrease their overtime pay. If a non-exempt employee pays for out-of-pocket expenses in the course of their work, and it brings their wages below the minimum (or cuts into overtime pay), then you should reimburse them for the expense by the next regular payday.
- Some state laws: Additionally, some states have laws that require you to reimburse particular expenses. For instance, California, Massachusetts, and Illinois require some form of mileage reimbursement, typically for employees that have to drive to different locations as part of their work, like field sales reps. You can visit your state's Department of Labor website to find information about requirements that apply to your company.
Sounds like a lot of information, right? It is. That's why it's best to create a reimbursement policy for your company, regardless of whether your state requires it or not.
What are Accountable vs. Non-Accountable Expense Plans?
In general, there are two types of plans you can use for reimbursing expenses: accountable and non-accountable. The plan type will determine whether or not your repayments are taxable or not.
Accountable reimbursements are not taxable, but they require more paperwork and stricter timelines. To qualify as an accountable, you must have a written reimbursement plan that meets the three requirements below:
- Business connection: The expense must have a business purpose. For costs that qualify as both work and personal, the business must only reimburse the portion of the costs related to work. For example, if a field sales rep uses their personal vehicle to visit clients, the company only reimburses for the miles used in the course of work.
- Proof of expense: Employees must provide adequate proof of the expenses within a reasonable period, usually within 60 days after the purchase. In most cases, you meet these criteria if you require your employees to keep and submit regular expense reports. An expense report includes the date, vendor name, amount, and description for each cost.
- Return any excess payments: This simply means that you require your employees to pay you back the difference if your reimbursement is higher than the cost. Typically, this is only needed if you reimburse them in advance. For example, if you give an employee $500 for a flight and it only costs $400, the employee needs to return the remaining $100 within a reasonable time, which is usually 120 days.
The IRS has different requirements for documentation and timeliness based on the expense and the situation. For the most up-to-date information, you can refer to IRS Publication 463, Travel, Gift, and Car Expenses. You may also find it helpful to talk to a certified accounting professional if you have any specific questions.
Reimbursement policies that don't meet the criteria for an accountable plan are referred to as non-accountable plans. Payments made under a non-accountable plan are treated as wages, which means they are reported as part of your employee's gross income, and they are taxed like normal earnings.
For example, let's say you have an employee who has a business trip coming up, so you give them a per diem (or daily allowance) of $65 for meals while traveling. If the employee only spends $50 on meals per day, and you don't require them to return the extra $15, this qualifies as a non-accountable plan because the employee didn't have to return the excess money you gave them. As such, the $65 daily meal allowance gets treated as wages and is added to their gross income.
In contrast, a per diem in an accountable plan would require that employees keep receipts for each meal, submit timely expense reports, and return any allowance money they didn't spend.
Furthermore, if you have an accountable plan, but your employees miss the timely deadlines, those reimbursements are treated as non-accountable and recorded as income.
For instance, an employee sends you a travel reimbursement request 90 days after they initially paid for the trip. Since the request came after the 60-day timeframe, the reimbursement is no longer accountable and counts as wages.
So, even if you have a written accountable plan, it's important to tell your employees about the timelines and reporting requirements so their reimbursements stay non-taxable.
As you can see, it's better to use an accountable policy so that you don't have to pay taxes on your reimbursements.
What Is the IRS Policy for Expense Reimbursement?
According to the IRS, payments under a non-accountable plan are considered income and are taxable, while those made under an accountable plan are not considered income.
Here's a quick breakdown of the income and tax implications for the two types of plans.
|Is it income?
|Do you pay taxes?
|Does your employee pay taxes?
|Yes. It is treated as wages and included in gross income on the employee’s W-2 form.
|Yes. You are responsible for payroll taxes on this amount, including FICA and unemployment taxes.
|Yes, income taxes. As the employer, you will usually withhold the employee’s portion of income taxes from the reimbursement.
How To Reimburse Employee Expenses
Reimbursing an employee for business expenses is a crucial part of the process, and it's where the employee actually gets the money back that they've spent on behalf of the company. Here's how to do it.
- Choose a payment method: You'll need to decide how you want to pay your employee back. You could include it in their next paycheck, send a separate check, or use a direct deposit. Some companies even use prepaid debit cards for this purpose. What's important is that it's a method that works for both you and the employee.
- Process promptly: Timing can be critical, especially if the employee has spent a substantial amount of their own money. Make sure to process the reimbursement as promptly as possible (within 30 days if you can). Some companies have specific pay cycles for reimbursements, while others handle them on an as-needed basis.
- Communicate: Let your employee know when they can expect the reimbursement. If there are any delays or issues, keep them informed so they're not left in the dark wondering when they'll be paid back.
- Keep records: Even though we're just talking about paying up, it's still essential to keep a detailed record of the reimbursement. This includes the amount, the method of payment, the date, and any relevant correspondence or approvals.
- Consider employee preferences: If possible, take the employee's preferences into account. Some might prefer a separate payment, while others might like it included in their regular paycheck. Being flexible here can increase employee satisfaction.
- Use technology: You can reimburse employee expenses using a payroll provider like Hourly, which lets your team members upload their receipts and allows managers to approve the reimbursement and add it to their team member's paycheck as non-taxable wages—all with a few clicks.
- Compliance with agreements and policies: Ensure that the reimbursement aligns with any agreements you have with your team, such as an employment contract, and follows your company's reimbursement policy.
In short, the "Pay Up" step isn't just about handing over money—it's a multifaceted process that requires thoughtfulness, communication, and attention to detail. Making it as smooth and transparent as possible can help build trust and goodwill with your employees.
Do Expense Reimbursements Count as Income?
Accountable reimbursements do not count as income since the employer is paying back the employee for a work-related purchase.
However, if the expense is considered non-accountable, then it gets treated as wages. This means that the amount gets included in the employee's gross income.
Are Reimbursements Tax-Deductible?
Employers can deduct accountable reimbursements as long as they are ordinary and necessary business expenses. For tax purposes, "ordinary" means that the expense is common in your industry, and "necessary" means they are helpful to growing your business.
Non-accountable reimbursements, on the other hand, are included in your wage expense. So you don't need to deduct them again from your taxes.
Are there Alternatives to Reimbursing Expenses?
Yes, you can opt to provide employees with company credit cards they can use to pay for work-related expenses without requiring a reimbursement.
Company or corporate cards are credit cards that the business pays for but allows employees to use.
While these may be easier than reimbursements, it's important to set clear instructions on when the employee can use the card.
You should also have someone monitor the credit card statements regularly since it's your business's money.
What To Know About Reimbursing Employee Expenses
For both small businesses and large enterprises, there may be times when employees have to pay for a business purchase out-of-pocket.
Under a traditional accountable plan, reimbursements are not treated as wages as long as they're for business purposes, your employees submit timely records, and you require that employees pay back any excess reimbursement.
Reimbursements that are requested late or lack the proper documentation are considered non-accountable and should be treated as wages. As a result, you and your employee will have to pay taxes on those payments.
While expense reimbursement is not always required, it's an excellent fringe benefit to give your employees so they don't feel like you expect them to pay for your business's costs.