Do your employees use their own vehicle for work, pay for food, travel, or maybe buy office supplies out of pocket? Have you been reimbursing them without knowing the rules regarding reimbursements and the many taxes that pay is generally subject to?
It’s a common problem for employers when they’re unaware of how to reimburse employees, but would still like to, especially knowing how important it is to the employee.
The good news is is that most reimbursements for employees are completely tax-free*.
And we’re assuming you saw that asterisk above so you know that’s not the full story.
*If you want to reimburse your employees tax-free, the IRS will expect you to have what is known as an accountable plan in place.
An accountable plan may sound overwhelming to implement, but in practice is quite easy. Substantiation for employee business expenses generally only requires a log of receipts and purpose of the expense.
In addition to this, reimbursements cannot exceed certain IRS rates. For example, when an employee uses their own vehicle for a work trip, you may reimburse them for mileage tax-free up to the pre-determined IRS rate.
This is done specifically so that employers and their accountants don’t get too creative and come up with ways to pay an excessive amount to employees tax-free.
Other rules are in place for general travel and meals, like per-diem (per day) rates.
In addition to being free from federal income tax, these reimbursements are free from Medicare, Social Security, FUTA, SUTA, and state income taxes.
If an accountable plan is not in place, you may still reimburse your employees, but with a major catch being that the reimbursements are not tax-advantaged like under an accountable plan.
With the Tax Cuts and Jobs Act eliminating the itemized deductions with the 2% limitation (meaning employee business expenses are no longer deductible), now is the perfect time to talk to your accountant about putting into place an accountable plan.
Being unable to be reimbursed for out-of-pocket expenses has been known to be enough to make a good employee look elsewhere.
Thank you for reading. This article is meant as general guidance but should not be interpreted to constitute tax or legal advice.