Expense reimbursements play a crucial role in both year-end and continuous financial planning. Understanding employee expense reimbursement is essential in this context. A key question often arises: are reimbursements taxable? To navigate this, it's important to delve into the intricacies of business expense reimbursement management. This involves comprehending the mandatory requirements and intricacies of the process. Additionally, we will address common questions regarding the establishment of a robust system designed to ensure compliance and efficient management of reimbursements.
What is Expense Reimbursement?
Employee expense reimbursement refers to reimbursing employees for certain business-related expenses incurred by the employees. The IRS generally defines business-related expenses as ordinary and necessary costs related to carrying on a trade or business.
An employee expense reimbursement plan should clearly outline the specifics on what types of expenses will be reimbursed and the plan should also be in compliance with governmental regulations regarding reimbursable expenses. The business is responsible for ensuring that employees on payroll receive compensation for meals, transportation, and other reasonable expenses that they incur as part of their job.
Steps to Creating an Employee Expense Reimbursement Plan
An Accountable Expense Reimbursement Plan
“Accountable Plans” generally allow for tax free reimbursement. An “accountable plan” has these three elements.
- Business Purpose: There must be a business reason for the expense.
- Validation: An employee should be able to supply receipts or invoices supporting and documenting the amount and nature of the expense being submitted for reimbursement.
- No Excess: Employees must return any amounts paid in excess of the validated expenses.
If instead a plan is not accountable (or otherwise does not satisfy the various governmental regulatory requirements) the amounts paid to employees could be considered income and thus included on Form W-2.
- Want to know more about Form W-2? Download our W-2 eBook.
The Five “Ws” and a Few Other Items
Employees can use per diem allowances for certain meal expenses. The General Services Administration sets per diem rates within the lower 48 states.
If actual reimbursement expenses are used instead of the per diem rates, the IRS has specific requirements, known as the five “Ws”:
- Who was there?
- Why is the meal considered business related?
- Where did the meal occur?
- What was the cost of the meal?
- When did the meal occur?
Deductibility of Per Diem Meals
The IRS recently issued favorable guidance related to the temporary 100% deduction for business-related food and beverages provided by a restaurant in 2021 and 2022. Notice 2021-63 clarifies that the meal portion of a per diem rate or allowance can be treated as attributable to food or beverages provided by a restaurant for purposes of applying the 100% deduction. This special rule is effective for expenses paid or incurred beginning January 1, 2021, through December 31, 2022.
Generally, business deductions for food and beverage expenses are limited to 50% of the amount that would otherwise be allowable (subject to certain exceptions). However, a provision in the Consolidated Appropriations Act, 2021, permits a full deduction for business-related food or beverage expenses if the food and beverages are:
- Paid or incurred during calendar years 2021 and 2022
- Provided by a restaurant
This temporary expansion of the deduction for food and beverages is intended to help the restaurant industry recover from the effects of the COVID-19 pandemic by encouraging businesses to patronize restaurants for business meals. This expanded deduction does not extend to entertainment expenses.
The IRS provided guidance on the definition of “provided by a restaurant” but didn’t address how the full deduction might apply for the meals portion of a per diem. Many taxpayers have questioned how these per diem amounts should be substantiated in order to qualify for the 100% deduction. With this latest notice, taxpayers that properly apply the per diem rules may treat the meals portion of a per diem rate or allowance paid or incurred in 2021 or 2022 as “provided by a restaurant.”
This is welcome guidance that may affect how businesses capture and track business-related meal costs in order to support a full deduction.
- Learn more about deductibility of meal and entertainment expenses and how recent legislation removes the usual 50% limit on deducting business meals provided by restaurants in 2021 and 2022.
The IRS also has rules when it comes to automobile expense reimbursements. The policy related to automobile expense reimbursements must describe how your employees use a vehicle for business expenses on company time. This applies to both an automobile owned/leased by your company as well as mileage reimbursement and personal use.
- Have employees who are using company automobiles for personal use? Download our Personal Use of Company Vehicle Guide.
Ensuring Your Expense Reimbursement Plan is DOL Compliant
The Department of Labor also has rules when it comes to expense reimbursements. These rules include:
- The five “Ws”: The DOL adheres to the five “Ws” when documenting all expenses to be reimbursed. Further, they require your employees to provide the original receipt and written description. If the receipt is lost, your policy must state you require a signed statement from the employee regarding the lost receipt.
- Substantiation for all: The IRS has an exception that allows you to not keep records for any expense (excluding lodging) less than $75. This is not true with the DOL. The DOL states that all reimbursed expenses must have the proper records, so you cannot skip this step.
- For meal expenses, the DOL requires itemized receipts: In other words, the credit card slip won’t work. You need the actual ticket that details what each person ordered, as well as the credit card slip indicating how much tip was left.
- Automobile rules: When it comes to organization-owned or leased vehicles, employees must furnish the date of travel, the number of miles driven, whether it was for personal or business and the odometer reading. If your policy also includes reimbursement for personal vehicles, the DOL states you have to have at least one record that includes the date of travel, locations traveled to and from, number of miles, and business purpose.
Why Business Expense Reimbursement Matters
As you plan for year-end, make sure your policy for employee reimbursement is compliant. By setting these rules in place, you’ll ensure your employees will not only have the information they need as they travel for work but also that your business follows the IRS and DOL regulations when it comes to the taxability of reimbursement of expenses to employees.