Are employee reimbursements taxable?

Correctly calculating your business tax liability can reduce your tax burden and help increase profitability. To do that, you need to accurately record all your business expenses and determine whether any expense reimbursements count as taxable income for your employees.

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In this post, we’ll define employee reimbursements and list some common reimbursable business expenses. We’ll also cover the IRS rules around when employee reimbursements are taxable vs. non-taxable. Let’s get into it.

What are employee expense reimbursements?

The IRS lays out a clear definition of what an employee reimbursement is. To paraphrase, an expense reimbursement is when an employer reimburses employees for properly substantiated business expenses they paid for out of pocket.

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For the expenses to be “properly substantiated,” the employee must (promptly) submit an expense report with supporting documentation, such as receipts. When your business complies with IRS requirements, the employee receives a non-taxable reimbursement.

Common types of reimbursable expenses

Employees often submit reimbursement requests for business-related expenses like:

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• Business travel expenses
• Meals and entertainment
• Office supplies
• Tools and equipment
• Personal development and training
• Using a personal vehicle for business purposes

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The tax rules regarding deductions for meals and entertainment have changed several times in recent years, so it’s especially important to keep a close eye on these charges. Currently, some meal and entertainment expenses are tax-deductible.

Are reimbursements taxable?

Whether employee reimbursements are taxable depends on how your business manages its reimbursement plan.

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In a nutshell, reimbursements paid through an accountable plan are not considered taxable income for the employee, while payments made using a non-accountable plan are considered taxable income. Let’s break down the difference between accountable and non-accountable plans and the requirements you need to meet for each.

Using an accountable plan

To be an accountable plan, your company’s reimbursement policy or allowance arrangement must follow these rules:

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1. Your expenses must have a business connection—that is, the employee must have paid or incurred deductible expenses while performing their job
2. Employees must adequately report these expenses within a reasonable period of time
3. Employees must return any excess reimbursement or allowance within a reasonable period of time

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Document your accountable plan and ensure your entire staff can quickly access plan details. A comprehensive and clearly written document reduces confusion about the plan and will speed up the reimbursement process.

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What is a “reasonable period of time”?

The so-called 30/60 rule clarifies the IRS requirement to report expenses within a reasonable period of time. What qualifies as a “reasonable period of time” depends on the unique circumstances of your situation, but the IRS provides some general guidelines.

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To illustrate these guidelines, let’s assume you’re a salesperson who travels frequently to see customers:

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• You receive a cash advance within 30 days of the time you incur an expense
• You adequately account for your expenses within 60 days after they were incurred
• You return any excess reimbursement within 120 days after the expense was paid
• You’re given a periodic statement (at least quarterly) that asks you to either return or adequately account for excess advances, and you comply within 120 days of the statement

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If you meet these rules for accountable plans, employee expense reimbursements aren’t subject to income tax.

Using a non-accountable plan

Reimbursements made under a non-accountable plan don’t comply with the accountable plan rules. In addition, even if you have an accountable plan, the following payments will be treated as being paid under a non-accountable plan:

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• Excess reimbursements your employees fail to return to your company
• Reimbursement of non-deductible expenses

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An arrangement that repays employees for business expenses by reducing wages, salary, or other pay is treated as a non-accountable plan. This is because employees are entitled to receive their total pay regardless of whether they’ve incurred any business expenses on your company’s behalf.

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As such, these types of employee reimbursements are subject to tax withholding, and the payment is added to the employee’s taxable income.

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Your relationship with your employees is valuable. It’s important that you understand when an employee reimbursement is taxable and communicate your reimbursement policy to your staff. This will help you maintain good relationships with your employees.

Can employees deduct unreimbursed business expenses?

The Tax Cuts and Jobs Act (TCJA) of 2017 suspended many miscellaneous itemized deductions starting in 2018. That means most employees can no longer write off unreimbursed business expenses on their tax returns—at least until many provisions of the TCJA sunset at the end of 2025.

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With that said, there are some special exceptions to these rules. The following individuals can deduct unreimbursed business expenses in certain circumstances:

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• Armed forces reservists
• Qualified performing artists
• Fee-based public officials
• Disabled employees with impairment-related work expenses
• Teachers

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Be sure to review what types of unreimbursed business expenses are deductible and under which circumstances. When in doubt, it’s best to consult a tax professional.

Other types of employee business expenses

You may need to manage several other types of expenses, each of which has its own tax considerations:

Per diem reimbursements

The IRS defines a per diem allowance as a fixed amount of daily reimbursement an employer gives an employee for lodging, meals, and incidental expenses when the worker is away from home on business.

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Many businesses use the per diem rates determined by the General Services Administration (GSA) to budget for travel. Per diem payments aren’t subject to taxes provided they stay below the GSA’s prescribed per diem rate. Of course, your company doesn’t have to use these per diem rates, but many businesses rely on them as a benchmark.

Moving expenses

The TCJA requires employers to include moving expense reimbursements in employees’ wages. As such, these reimbursements are subject to income and employment taxes—at least until the law sunsets in 2025. Generally, members of the US Armed Forces can still exclude qualified moving expense reimbursements from their income.

Fringe benefit payments                                

The tax code defines a fringe benefit as a form of pay for the performance of services. For example, when you allow employees to use a business vehicle to commute to and from work, you provide a fringe benefit.

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A taxable fringe benefit must be included in the employee's pay unless the law excludes it. IRS Publication 15-B lists some exceptions to the rule, including:

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• Accident and health benefits
• Dependent care assistance
• Educational assistance
• Employee discounts
• Retirement planning services
• Commuting benefits
• Tuition reduction

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Maintain solid employee relationships by communicating fringe benefit details to your staff. Explain the fringe benefits you provide and whether or not the fringe benefit generates taxable income for the employee.

Simplify expense management and reimbursements with Ramp

Employee reimbursements can be one of the trickiest elements of small business taxes. Ramp’s expense management platform can help you get it right.

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Ramp unifies all your corporate spending data in one place. Our software automatically categorizes business expenses so you always have a clear and accurate view of which expenses are deductible and which aren’t. Ramp can even automate your expense reporting and approval workflow, helping you reimburse employees faster with less manual work.

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Want to learn more? Watch a demo video and see why businesses that choose Ramp save an average of 5% a year.