Small businesses pay 21% in federal taxes, and 44 states tack another 4-9% on top of that. That’s a significant portion of your small business revenue, and equates to hours of accounting to get it right.
We’re covering one of the more complicated elements of small business taxes—employee reimbursements. This guide will help you determine if employee reimbursements should count as taxable income and how to record them.
What are employee reimbursements?
Throughout the regular course of work, employees will occasionally need to pay for business expenses with their own money. Whether it’s gas, meals, mileage, client entertainment, or an Uber, employees will need to be paid back for expenses incurred during business operations.
Even when employee reimbursements are rare, it’s a good idea for companies to establish a reimbursement policy to ensure that employee expenses are reasonable, recorded, and paid back in a timely manner.
Are reimbursements taxable?
Taxes for small businesses can be complex, so it’s important to track each and every business expense properly. No one wants to be surprised when tax season rolls around, finding that they owe more than expected or that they lack the proper documentation for exemptions they’ve earned.
Generally payments made to employees are subject to taxes, so the employer will withhold and then contribute those taxes on behalf of the employee (read more about your tax responsibilities as an employer in the Publication 15 of the IRS). Reimbursements are handled a little differently, though, and the taxes in question are determined by the type of plan you use: accountable or nonaccountable.
What is an accountable plan?
The most common choice for employers is an accountable plan. An accountable plan is not taxable, as long as it follows these specific guidelines:
- The reimbursement is for expenses incurred for company purposes.
- The expense was documented in a reasonable amount of time, with identifying information such as amount, time, place, and purpose for the purchase.
- Any excess reimbursement is returned to the employer in a reasonable amount of time.
What is a “reasonable amount of time”?
According to the IRS, here are the timeframes for reimbursable expenses:
- Employees need to document expenses within 60 days of purchase
- Employers need to issue an expense reimbursement within 30 days of purchase or documentation of purchase
- Excess reimbursements need to be returned within 120 days
As long as these rules are followed, you will not need to pay taxes on employee reimbursements. However, if an employee fails to follow the rules then taxes will need to be withheld. For example, if the business expense isn’t reported in a timely manner or if excess isn’t returned then taxes will need to be withheld and contributed for the expense total.
Under an accountable plan you don’t need to record these reimbursements as taxable wages—you’ll just record them in box 12 of the W-2 form.
What is a nonaccountable plan?
A nonaccountable plan is utilized when expenses aren’t conducive to an accountable plan, and will therefore be subject to taxes. Nonaccountable plan reimbursements will require paying income taxes, FICA taxes, and unemployment taxes.
A nonaccountable plan would include
- Expenses that don’t need to be reported
- Allowances or budgets that don’t need to be returned
- Reimbursements that would otherwise be wages
Essentially reimbursements under a nonaccountable plan are wages, and need to be recorded on the employee’s W-2.
How do I tax per diem reimbursements?
If your business requires travel regularly, it may make more sense to allow per diem expenses. A per diem is a daily allowance for food, mileage, hotels, taxis, and other expenses that may be incurred when an employee is required to travel for work purposes.
The current per diem allowance for the continental U.S. in non high-cost localities is $151 per day. Check the GSA per diem rates for updated and localized rates.
Per diem payments are not subject to taxes, so long as they stay below the prescribed per diem rate. Anything spent over that rate and reimbursed by the company will need to be reported as wages and taxed accordingly.
Frequently Asked Questions
Are moving expenses taxable?
Yes, moving expenses are counted as taxable income, whether it’s a relocation bonus, moving allowance, or moving expenses paid directly by the company. The employee will be taxed for these additional amounts as if they were wages or income.
What are fringe benefits and are they taxable?
Fringe benefits are additions to the general compensation expected by employees, which help to attract and maintain talent. Common fringe benefits would include health insurance, life insurance, snacks or meals in the workplace, employee discounts, stock options, company cars, or child care. Generally, fringe benefits are exempt from taxes so long as they stay under acceptable limits as outlined by the IRS Publication 15-B regarding fringe benefits.
Are medical expense reimbursements and health insurance taxable?
Medical expense reimbursements are tax-free for employees, and tax-deductible for employers. Health insurance is not taxed for either employer or employee.
Save time with your reimbursement process
With a well-constructed reimbursement plan in place, most businesses can utilize an accountable plan and avoid taxing the reimbursements for business expenses. But even when taxation is necessary under your nonaccountable plan, it’s fairly easy to manage. We encourage you to analyze your employee expenses and expense reimbursement process to allow for quick and painless reimbursements.