Tax Category Tax: calculations, VAT, self-employment tips and more

Tax Implications of Expense Reimbursement Through Payroll

During the course of business, expenses are incurred that are directly attributable to specific projects.

Oftentimes, these business expenses are initially paid by employees and are later reimbursed by the employer.

In other instances, the employer provides employees with a set amount per day in advance. Regardless of the method of payment, the tax implications for substantiated business expense reimbursements are of little consequence to the employee.

Common Reimbursements

Airfare, mileage and meals are examples of business expenses that are commonly reimbursed. In order to qualify for reimbursement, the expenses are classified as ordinary business expenses and are substantiated. Unfortunately, reimbursements are often abused in organisations where employees request reimbursement for expenses that were not incurred. For this reason, many organisations provide employees with a list of expenses that are commonly reimbursed, documents needed to prove the expense, and methods of payment.

Reimbursement Procedure

According to the Internal Revenue Service (IRS), the amounts employers pay employees to reimburse them for substantiated business expenses are not subject to income tax or employment tax. However, an employee's gross pay is subject to federal tax withholding, social security and Medicare taxes. For instance, an employee earned £650 for payroll and is due a reimbursement of £32 for a gross total of £682. The £650 payroll is reduced £195 for federal withholding, social security and Medicare tax for a net payroll of £455.

The expense reimbursement of £32 is not reduced for income tax or employment tax and is added to the net payroll of £455. The total payment for payroll and the expense reimbursement is £487.

Per Diem

Per diem, or "per day," refers to amounts that are paid to employees based on estimated daily expenses. Per diem rates are established on an annual basis by the United States General Services Administration and vary with locality. If employers pay amounts to employees in excess of the annually determined per diem rates, the excess amounts are subject to income tax and employment tax on Form W-2 as earned income.

Unsubstantiated Reimbursements

Unsubstantiated reimbursements, or reimbursements without receipts or other backup, may be included in the employee's taxable income. The IRS requires employers to provide proof of expenses that are deductible on a business' income tax return.

Reimbursements that are not tracked could result in IRS denial of previously deducted expenses.

The denied expenses are additional income for the employee and are included on Form W-2. The employee and the employer are required to pay social security and Medicare tax on unsubstantiated amounts.

Unreimbursed Expenses

According to the IRS, employees may be able to deduct unreimbursed work related expenses as an itemised deduction on Form 1040, Schedule A. In order to deduct the expenses on Schedule A, the expenses require supporting documentation and must be required by the employer. Other unreimbursed business expenses deductible on Form 1040 are certain local transportation expenses and expenses related to maintaining a home office.