Business Expense Reimbursements

Many businesses reimburse their employees when the employees pay for business-related travel, entertainment, or other types of expenses. But how can you make sure that these reimbursements will not trigger additional payroll taxes for you and your employees?

First of all, the expenses must be bona fide, ordinary and necessary expenses incurred or reasonably expected to be incurred to further your business. The IRS grants you wide latitude here the main concern is that you are not trying to write off personal living expenses, or perks that are mainly designed to provide additional pay to the employees. Each type of expense must meet the regular IRS rules (if any) for deducting that type of expense; for example, meals and entertainment expenses are only deductible under certain circumstances, and there are strict rules for deducting car-related business expenses.

If that test is met, you're not out of the woods yet. The advances and reimbursements will still be taxable to the employee unless they are made under an "accountable plan." An accountable plan is one that has the following three characteristics:

  1. It provides for advances or reimbursements for deductible business expenses that employees incur in connection with their performance of services for their employer (as discussed above).
  2. It requires employees to substantiate the expenses (i.e., with receipts and detailed expense reports) within a reasonable time.
  3. It requires employees to return any advances or reimbursements in excess of substantiated expenses within a reasonable period of time.

Any amounts you pay to employees that exceed the substantiated expenses are taxable wages, unless the employee returns the excess to you within a reasonable period of time.

If the reimbursements are not made under an accountable plan, the payments will be subject to payroll taxes. However, note that the employee may be able to deduct them (as employee business expenses, which are included as miscellaneous itemized deductions) on his or her individual income tax return.