Independent contractors, consultants and freelancers face plenty of professional challenges, including learning to master complicated tax rules. Reimbursement of valid business expenses is not usually taxable to the contractor, assuming he meets the rules of adequate accounting and record keeping.
Contractors vs. Employees
Independent contractors differ from employees for tax purposes. Generally, the IRS looks at which party ultimately has control over the work product and who is the decision-maker to determine whether someone is an employee or a contractor, although the IRS may consider any relevant facts and circumstances. Contractors receive agreed-upon fees for services provided to the client without any withholdings for tax purposes. Companies that pay an independent contractor $600 or more for services provided during the year must provide the contractor with a Form 1099-MISC by January 31 of the following year. Clients may reimburse contractors for reasonable business expenses, but doing so for a large volume of expenses indicates to the IRS a contractor was actually an employee for tax purposes in Revenue Ruling 55-144.
To be reimbursed for expenses incurred on behalf of a client, the contractor provides an invoice with adequate accounting for expenses to the client. Generally adequate accounting includes a detailed list of expenses and receipts if requested by the client. Assuming the client reimburses valid business expenses, the contractor will not report the reimbursement as income, nor will he deduct the expenses as business expenses. The reimbursement will not be reflected on the contractor's Form 1099-MISC.
If the contractor neglects to provide a detailed list of business expenses to the client, the reimbursement, if it is paid, is included as income to the contractor on Form 1099-MISC. Assuming the contractor maintained sufficient records of the expenses, he may deduct the expenses on Schedule C of Form 1040.
The taxpayer claiming the deduction -- either the contractor or the employer -- must substantiate business expenses. Save receipts or records of expenditures, such as cancelled checks or credit card statements. In addition, document the details of each expense, including the business purpose and the parties involved -- for example the attendees of a meal. Also record the date of expenses; where the expense was incurred, including the venue and the city if it is a travel expense; and an itemized list of each expense.
On occasion, independent contractors hire subcontractors to complete certain engagements who may be classified as employees or contractors for tax purposes. In these cases, the original contractors become employers and must adhere to the same rules governing expense reimbursement, albeit from a different perspective.
- IRS.gov; Publication 463: Travel, Entertainment, Gift, and Car Expenses; February 2011
- IRS.gov: 2011 Instructions for Form 1099-MISC
- “Business Law Today”; Do’s and Don’ts When Using Independent Contractors; Robert W. Wood; June 2011
- TurboTax.com; Tax Topics for Freelancers, Contractors, and Consultants; 2010
- Entrepreneur.com; 75 Items You May Be Able to Deduct from Your Taxes; Mark J. Kohler; April 2011
- ArticleClick.com; Managing Reimbursable Business Expenses; Nick Kakolowski