There are many situations in which it becomes necessary or convenient for your employees to make expenditures on behalf of the company. Understandably, employees are reluctant to spend their own money if they won’t be reimbursed by the company.
That is why it is important to have and communicate a clear expense reimbursement plan. This will lay out all of the types of expenses that the company agrees to reimburse, amount limits for specific categories, any preapproval needed, the format for expense reports and when expense reports are due. Sticking to your expense reimbursement plan will help you keep expenses in check. Here’s what you need to know about expense reimbursements.
Employee expense reimbursement is when employers pay funds back to employees who have used their own money to pay for business-related expenses. Employees are usually not required to report expense reimbursements as either income or wages. According to the IRS Employer’s Tax Guide (Publication 15), if the business has an “accountable plan,” it doesn’t have to count expense reimbursements as part of its employees’ wages.
To qualify as an accountable plan, an expense reimbursement policy must meet the following conditions:
Employee reimbursements paid under an accountable plan are not considered wages, so these payments are not subject to any taxation. However, if the expenses do not meet the above criteria, the employee reimbursement is treated as paid under a nonaccountable plan. This amount becomes subject to taxation in the next payroll period.
Make sure your plan is considered an “accountable plan” to qualify for tax deductions. Otherwise, the IRS could see your reimbursements as taxable wages.
There is no fixed definition for a “reasonable” amount of time, as the time period depends on the circumstances. The IRS considers it reasonable to:
Any payments made to employees for necessary business expenses under a nonaccountable plan count as supplemental wages, which means they are subject to all applicable income and payroll taxes. Payments qualify as part of a nonaccountable plan if they meet one or more of the following criteria:
The pandemic increased the amount of employees engaging in remote work, and it is a trend that continues. Employers can use work-from-home reimbursements to cover some of the expenses that employees incur from remote work. A remote work reimbursement may cover:
According to the Fair Labor Standards Act, employers must provide work-from-home reimbursement to cover expenses that would lower the employee’s hourly wage rate below the minimum wage.
Work-from-home reimbursements are not taxable if they fit the criteria of the accountable plan.
Employee expenses that the employer must reimburse are subject to the rules of deductible business expenses. As IRS Publication 535 says, “To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your industry. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary.”
These are some examples of ordinary and necessary expenses:
Expenses that could qualify for employer reimbursement typically fall into one of these categories:
If an employee purchases supplies for business purposes, the employer can reimburse the expenses at cost.
According to the IRS, travel expenses are ordinary and necessary expenses when an employee has to travel to do their job. Employees can be reimbursed for using their personal vehicle for business. The IRS sets the standard mileage rate for reimbursing an employee’s business-related use of their vehicle. (The commute from home to work is not usually a reimbursable expense.)
Transportation expenses are separate from travel expenses that the employee incurs while traveling away from their home area. The employer may reimburse transportation expenses if the employee is traveling to a temporary workstation under one of the following circumstances:
You can reimburse employees for meal and entertainment costs that they incur within the employee’s tax home if those expenses have a clear business purpose. Employees can be reimbursed for 100 percent of meal and entertainment costs, although employers can deduct only 50 percent of the cost.
You may reimburse employees with a fixed allowance (e.g., fixed travel days or miles). Under this arrangement, the employee has sufficiently accounted for their expenses as long as the reimbursement rates are in line with government-established rates. You can find details of the government per diem rates for meals and accommodations on the U.S. General Services Administration website. IRS Publication 15-B lists the standard mileage rates to cover driving expenses.
If your employees give gifts as part of doing business, you can reimburse them for the cost of those gifts. You can deduct a maximum amount of $25 per person per year for gifts. If an item your employee gives a client could be considered either a gift or entertainment, it defaults to the entertainment category.
These are some other expenses you can reimburse your employees for on a tax-free basis:
Each of these nontaxable reimbursements falls into its own category with specific guidelines on taxability.
According to the IRS Employer’s Tax Guide to Fringe Benefits (Publication 15-B), a fringe benefit is “a form of pay for the performance of services.” Therefore, fringe benefits are taxable. Even if a third party actually provides the benefit (e.g., a gym provides the workout equipment and classes), the employer pays to provide the fringe benefit. The employee receives the fringe benefit in exchange for providing their services to the employer, even if another person receives the benefit without performing services in exchange for money (e.g., the employee’s spouse uses the gym membership).
These are some examples of fringe benefits:
While the value of a fringe benefit is taxable (e.g., federal income tax, Social Security tax, Medicare tax, FUTA tax), the taxable portion of a fringe benefit may be reduced by the amount legally excluded from compensation or paid for by the recipient.
As the employer, you must create an accountable plan to reimburse your employees for expenses; otherwise, this expense will be subject to payroll taxes. According to IRS Publication 15, “Payments to your employee for travel and other necessary expenses of your business under a nonaccountable plan are wages and are treated as supplemental wages and subject to the withholding and payment of income, Social Security, Medicare and FUTA taxes.”
If you have an accountable plan, the business expenses you reimburse to an employee are not treated as wages and not taxed. You do not report this amount with the employee’s wages on Form W-2; you should record the amount in box 12 of Form W-2, with code L.
Reimbursable expenses are subject to federal income tax limitations for specific expenses (e.g., listed property, meals, gifts).
Create a spreadsheet with the expense report format you prefer. Distribute this blank form to all employees who need to be reimbursed for business expenses. The form should include space for:
Not every expense that an employee puts on the expense report necessarily ought to be paid. Companies universally will not want to reimburse the employee’s personal expenses. You may have a rule that you reimburse expenses for corporate gifts, but only up to a set amount. Corporate gift expenses above that amount would not be approved.
In addition, you may have a general rule for certain expense categories. For example, your company rule may be that work-from-home employees can have the cost of their internet service reimbursed, but they cannot be reimbursed for buying a new computer. Clearly communicate these rules to all employees so there is no frustration or disappointment later.
Once the employee has filled out an expense report, he or she needs to know where and how to submit it. This may be the employee’s direct supervisor, a department head, an executive or someone in your accounting department. This responsible party needs to let employees know the expected time frame to submit expense reports once the expense has been incurred.
The person in charge of approving expense reports should let the employee know about any expenses that have not been approved and the reasons for that. Approved expense reports should then be passed along to accounts payable to be paid.
You should keep detailed payroll records, including records of employee reimbursements. You can reimburse employee expenses in one of two ways:
Make sure you reimburse employees in a timely fashion since they have laid out their own money to pay company expenses.
Requiring employees to submit original receipts along with their expense reports keeps the document honest and provides you with necessary paperwork for tax time.
While you can track reimbursable expenses in a spreadsheet or a ledger, it is much easier and more accurate to use a combination of accounting software and payroll service. We have reviewed the most popular ones, picking the best accounting software solutions and top payroll services. Here are some of the top ones for keeping track of and paying reimbursable expenses.
QuickBooks is the most popular accounting software for small businesses. Its least expensive plan, the Self-Employed plan, includes expense tracking, helps you manage receipts and tracks mileage. QuickBooks Online allows you to track all of your expenses and bring them into an accounts payable system. Another benefit is that since QuickBooks is so widely used, nearly all accountants and bookkeepers already are familiar with it and know how to use it. Read the full QuickBooks Online review for more details.
FreshBooks is another great choice of accounting software for tracking and paying reimbursable employee expenses. It has the capability to create professional invoices and track and bill expenses. So if you have reimbursable employee expenses that can be passed along to the client, you can easily do that, a feature that is not common among accounting software solutions. FreshBooks connects to your business checking account and credit card accounts, automatically importing your expenses each day. If you have corporate credit cards that you issue to employees for expenses, this simplifies the expense report reconciliation process immensely. Find out more in our complete FreshBooks review.
ADP Workforce incorporates automated expense tracking by taking expense data from bank feeds, credit cards and OCR receipt capture. Employees can use the ADP mobile app to capture receipts while in the field and submit them without delay. In addition, ADP’s TripLog Drive GPS device automatically tracks employee business miles, tolls, parking, lodging and other expenses for business-related trips. To learn more, read the full ADP review.
Like ADP, Paychex has a mobile app that allows employees in the field to upload receipts. In addition, the app incorporates the company’s expense reimbursement rules so that any expenses that do not conform will generate a notification to the employee that they will have to be reviewed for approval. Then the app notifies the appropriate manager of the questionable expenses for closer scrutiny and allows two-way communication so the manager can ask the employee questions about the expense. You can also use the app to communicate any changes in expense reimbursement policy to employees. This enhanced communication speeds up the approval process so employees can get reimbursed quicker. Discover more about Paychex in our full review.
Both ADP and Paychex allow you to pay employee reimbursable expenses while keeping them separate from regular payroll for tax purposes.
David Gargaro contributed to this article.