When employees, or owner-employees of a corporation, pay for business expenses personally, the business can reimburse them. Whether that reimbursement is taxable wages depends on whether it is made under an accountable plan. The rules are described in Publication 15 and Publication 463.

The three requirements

A reimbursement arrangement is an accountable plan if it meets all three:

  1. Business connection: the expenses were paid or incurred while performing services as an employee
  2. Substantiation: the employee accounts for the expenses within a reasonable period, with receipts and details of amount, time, place and business purpose
  3. Return of excess: the employee returns any advance or allowance exceeding substantiated expenses within a reasonable period

Reimbursements under an accountable plan are excluded from wages, not reported on the W-2 and not subject to withholding. Payments under a nonaccountable plan are wages.

Reasonable periods

The IRS provides safe harbor timing, such as substantiating expenses within 60 days after they were paid or incurred and returning excess amounts within 120 days. Many businesses set a monthly expense report deadline, which is well within the safe harbor.

Mileage and per diem

Reimbursing mileage at no more than the federal standard mileage rate, with a log of business miles, satisfies substantiation of the amount. Per diem allowances for travel at or below federal rates can also be treated as substantiated if time, place and purpose are documented.

Owners of corporations

Owners of S and C corporations are employees of the corporation. An accountable plan is the clean way to reimburse them for business use of a personal phone, home office costs or mileage. Without one, the corporation may pay personal expenses that become wages or distributions instead.

Sole proprietors and partners

Sole proprietors cannot reimburse themselves; they deduct business expenses directly. Partnerships have their own rules for reimbursing partners, typically under the partnership agreement.

Setting it up

  1. Adopt a short written policy describing the three requirements and deadlines
  2. Use one expense report format or app for everyone
  3. Require receipts and business purpose for each item
  4. Reimburse from the business account and record the expense in the right category

In your books

We record reimbursed expenses in their underlying expense accounts, such as travel or supplies, not in a single reimbursement account. Allowances paid without substantiation are routed through payroll as wages. See also travel and meal expense records.

Setting up an accountable plan step by step

  1. Write the policy down. A short written policy should state which expenses are reimbursable, the documentation required, the deadline for submitting claims and the deadline for returning advances that exceed actual costs.
  2. Choose reimbursement methods. Decide whether you reimburse actual costs, use the IRS standard mileage rate for vehicles, or use per diem rates for travel. The IRS explains per diem and mileage substantiation in Publication 463.
  3. Create a simple claim form or app workflow. Each claim should capture the date, amount, business purpose and attached receipt.
  4. Review before paying. Someone other than the claimant should approve the claim, especially for owners of S corporations reimbursing themselves.
  5. Record it consistently. Post approved reimbursements to the same expense accounts the business would use if it paid the vendor directly, not to wages.

Common mistakes

  • Paying a flat monthly "allowance" without substantiation, which generally makes the payment taxable wages
  • Letting claims pile up for months, which weakens the timeliness requirement
  • Reimbursing an owner's personal expenses mixed in with business ones
  • Recording reimbursements through payroll, which inflates W-2 wages