Are Employee Reimbursements Taxable?

Taxes can significantly affect a company’s profitability, so it’s crucial that they are calculated accurately each year. One area that can be tricky to figure out are employee reimbursements. 

So, we’ve compiled information about how to determine when employee reimbursements are taxable, the difference between an accountable plan and a nonaccountable plan, and how to ensure you are adhering to the IRS’s rules for employee reimbursements.

What are employee reimbursements?

Employee reimbursements refer to expenses that employees have to pay for out of pocket during the course of doing business. These could include transportation expenses like taxis or Ubers, gas and mileage for business travel by personal car, and client entertainment like meetings over dinner or drinks.

Using methods like virtual cards can significantly reduce the number of reimbursements that need to be recorded and repaid, but nevertheless, it is helpful to have an employee reimbursements policy in place. This will ensure that employees are spending within reasonable limits, transactions are recorded accurately and employees are paid back in a timely manner.

Are reimbursements taxable?

Typically, payments made to employees via payroll are subject to taxes, which is why most employers withhold a percentage of earnings to be paid on behalf of employees. Reimbursements, however, are not the same as regular wages.

Depending on whether the employer uses an accountable or nonaccountable plan, reimbursements are handled differently.

Accountable Plan

Accountable plans are not taxable, provided the meet all of the following three requirements:

1. The expenses must be incurred in the course of conducting business (i.e. performing tasks for or on behalf of the employer). This does not include any personal expenses. If an expense is partially business and partially personal (e.g. driving a personal vehicle for a business purpose) it must be allocated between the two categories. 
2. The employee must adequately account the expense to the employer within a reasonable amount of time (60 days). It must include details of the transaction, including time, place and amount of the purchase, as well as the reason it was required for business.
3. The employee must return any excess reimbursement within a reasonable period of time. The IRS states that excess reimbursements must be returned within 120 days.

If all of these requirements are met, employers do not need to pay taxes on employee reimbursements. 

However, if any of the qualifications aren’t met (e.g. the time limits are not met or excess reimbursements are not returned), taxes will be withheld. In these cases, the transactions should be recorded as expenses on a W-2 form. 

Nonaccountable plan

A nonaccountable plan is one that does not meet the aforementioned criteria to be considered an accountable plan. 

These plans typically involve an employer giving a set allowance to an employee for business needs like travel. The employee does not have to account for these funds to the employer, and as such, the allowance is considered taxable income. This should be recorded on the employee’s W-2 form, as well.

Taxing per diem reimbursements

For companies that require frequent travel, per diem reimbursements are another option. These are daily allowances during the course of business travel to cover expenses incurred like transportation, lodging and meals.

Reasonable per diem rates are established by the General Services Administration (GSA) for the lower 48 states. View an updated list and search per diem rates by state here. You’ll notice that price ranges can vary greatly depending on the location and time of year of your business travel.

So, are per diem reimbursements taxable? Since they are not wages, no they are not taxable — but there are conditions. In order to not be taxed, per diem reimbursements require:

• That the fees incurred are equal or lesser than the federal per diem rate
• Employees to file an expense report with their employer that includes the business purpose of the trip, the date and location of the trip, and receipts for lodging

Thus, any reimbursements that exceed the federal per diem rate or are not submitted with an appropriate expense report will be considered wages and subject to taxes.

Complying with IRS rules

Remember to always comply with IRS rules to avoid penalty. There are extensive resources available on the IRS website, but we’ve compiled a list of some top tips to stay on track.

1. Expenses must be ordinary and necessary

The IRS defines an ordinary expense as “one that is common and accepted in your trade or business,” while a necessary expense is “one that is helpful and appropriate for your business.” It does not need to be required for business to be considered necessary.

2. Nondeductible expenses will be treated as nonaccountable

If an expense is not ordinary or necessary, it is not deductible and reimbursements for such expenses will be treated as nonaccountable, as it does not meet the criteria for an accountable plan.

3. Make sure to file the correct information on the correct paperwork

See the IRS chart Table 6-1. Reporting Travel, Nonentertainment Meal, Gift, and Car Expenses and Reimbursements for detailed instructions on completing the employer’s Form W-2 and the employee’s Form 2106.

FAQs

Are allowances for company vehicles taxable?

If an employer provides an employee with a car, employees can deduct the actual expenses of operating the car for business use. The deductible amount depends on the amount the employer includes in your income, as well as if the car was used for both personal and business purposes. The amount included as employee income would be subject to tax.

Are medical expense reimbursements taxable?

Medical reimbursements are not considered wages, so they are not taxed for employees. They are tax-deductible for employers.

Want to learn more about how Mesh Payments can help facilitate employee reimbursements? Book a demo with one of our reps today.

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