By following specific rules of the Internal Revenue Service, corporations may provide tax-free reimbursements to employees—including officer shareholders. The reimbursements must cover actual expenses incurred by an employee while conducting business services for the employer.
Employees must provide an adequate record that documents the business nature of the expense, the date, and the amount. A request for reimbursement must be submitted within a reasonable time after the expense is incurred. The IRS normally considers a reasonable time as sixty days.
An employer may advance funds to an employee for payment of future business expenses that the employee is expected in incur. Later, the employee must return with the required record of receipts for the expenditures.
Employees must return any excess advances for which receipt records are not provided to employers. For expenses that lack a receipt—such as tips during business travel—an employee only needs a record that meets IRS requirements for the purpose, date, and amount. The IRS considers thirty days as a reasonable time for providing expense records following an advance for reimbursement.
Corporations that provide reimbursements to employees are required to have an accountable plan under IRS rules. An accountable plan is required to (1) reimburse only reasonable expenses that have a business connection, (2) maintain reasonable accounting for the reimbursed expenses, and (3) assure that employees return any advances in excess of actually incurred business expenses within a reasonable time.
Employee reimbursements made under an accountable plan are not considered income to employees. Consequently reimbursements that meet accountability standards are not subject to payroll taxes. Instead, the corporation simply records the expenses as if they had paid them directly instead of reimbursing employees for them. Reimbursements to employees that do not meet accountability requirements are added to employee compensation and reported in Box 1 of From W-2. Therefore, amounts paid to employees who do not provide adequate expense records are taxable compensation.
Reimbursements for mileage must cover vehicle use incurred by an employee conducting business services for the employer. The IRS rules for adequate records apply to corporations reimbursing employees for business mileage. The employer must receive a record that documents the date, place, and business nature of vehicle use. A single record is acceptable for an uninterrupted round trip involving several business purposes. An uninterrupted round trip allows for minimal personal use, such as stopping for lunch between business locations. In addition, to remit reimbursement for mileage, a corporation must obtain an employee’s accounting of business miles driven within a reasonable time.
Mileage reimbursement is not added to an employee’s taxable compensation if the mileage has a business purpose that is documented to the employer and not in excess of the IRS standard mileage rate determined annually.