Tax Implications of Expense Reimbursement Through Payroll

Tax Implications of Expense Reimbursement Through Payroll
Man in suit pumping gas

Employee Business Expenses

As company representatives, employees tend to incur business expenses while working. Driving to meet a customer, picking up some office supplies or taking a customer out to lunch are all business expenses that may be reimbursed by the employer. To document and justify expenses, employees should save copies of receipts when making business purchases. The IRS allows employers to reimburse employees by the mile for car travel, so employees may keep a detailed log of business trips rather than saving gas receipts.

Accountable and Non-Accountable Plans

When employers reimburse employees for work expenses, they do so under either an accountable plan or a non-accountable plan. An accountable plan is one in which the employee provides timely documentation of expenses and returns any excess reimbursements. The employer verifies the expense had a business connection and retains copy of the documentation. Under an accountable plan, the expense reimbursement isn't income. Instead, it's a tax-free reimbursement of expenses to the employee.

Issuing Checks under an Accountable Plan

If you have an accountable plan, expense reimbursements shouldn't be processed through payroll. Instead, ask employees to periodically gather documentation of expenses and then issue an expense reimbursement check. These payments should be recorded as company expenses. For example, if you cut an employee a mileage reimbursement check for $50, that $50 should be recorded as mileage expense. Your company will be able to write off these expenses on its business tax return, so retain copies of mileage forms and receipts to substantiate the expense.

Payroll Processing for Non-Accountable Plans

If the employer doesn't follow the rules of an accountable plan, it's operating under a nonaccountable plan. Sometimes an employer purposefully implements a nonaccountable plan to minimize recordkeeping. For example, a company may choose to give employees $500 each to cover food and mileage expense for a annual business training and not require receipts. In this case, the expense reimbursements are actually considered wages and the employees will pay taxes on them.

Since these are considered to be wages, expense reimbursements under a nonaccountable plan should be processed through payroll. That way, the employer can withhold federal, state and payroll taxes. At the end of the year, expense reimbursements will be reported as wages in the employee's Form W-2.