The IRS is concerned about employee reimbursements because they involve the employer giving money to an employee—which looks an awful lot like (taxable) income. Yet, no income tax is owed on reimbursements. Because of the potential for abuse, the IRS has imposed rules to make it harder to get reimbursements for business expenses.
IRS reimbursement rules require you to:
- make an “adequate accounting” of the expense—for example, keep receipts or supply any other appropriate records (except for travel, meal, and entertainment expenses below $75, or travel and meal expenses paid on a per diem basis)
- submit your expense report and receipts to your employer in a timely fashion, and
- promptly return any payments that exceed what you actually spent for job expenses.
If you fail to follow these rules, your employer must treat the reimbursement paid to you as income subject to tax and to include the amount on your W-2. You’ll then have to deduct the expense on your personal tax return as described below.
What if you seek reimbursement for something that you buy for both work and personal use? You must include the fair
market value of the personal use of the item as part of your compensation. That is, your employer must add the value of your personal use of the item to the compensation shown on your W-2 form, and you must pay tax on it. For example, if your employer reimburses you for a $2,000 computer that you purchase and use 100% for work, the reimbursement is tax-free to you. But if you use the computer only 50% of the time for work and the other 50% for personal purposes, you’ll have to pay income tax on 50% of its fair market value.
Deducting your unreimbursed work expenses
If your employer won’t pay or reimburse you for some of your workrelated expenses, you might be able to claim them as personal, itemized deductions on your personal income tax return. They are subject to the same rules and limitations as business expense deductions for selfemployed people. The most important rule is that the expenses are deductible only if they are ordinary, necessary, and reasonable.
Because you are an employee, your unreimbursed business expenses are deductible only to the extent that they (along with your other miscellaneous deductions) exceed 2% of your adjusted gross income (“AG I”). Other possible miscellaneous itemized deductions include investment expenses, tax preparation fees, hobby expenses, and a few
others. Your AG I is your income after adjustments to income and business deductions have been subtracted.
It works like this: Assume your AG I is $50,000 and your only itemized deduction is $1,500 you spent on a sales trip that your company won’t reimburse you for. First, you figure out your limitation, which is $1,000 (2% of $50,000). You can deduct your business expenses only to the extent they exceed $1,000—which means you can deduct only $500 of your $1,500 business expense.
Because of this rule, the higher your AG I, the fewer expenses you’ll be able to deduct. It doesn’t seem fair, does it?