How do we reimburse employee expenses without making them taxable?

01The accountable plan: three rules from the IRS#

An accountable plan is the IRS’s name for a reimbursement arrangement that meets three conditions, set out in the regulations under section 62 of the Internal Revenue Code and summarized in IRS Publication 463. Payments that meet all three are excluded from the employee’s wages.

A plan doesn’t have to be a formal document to qualify, but writing it down is how you prove the rules exist and are followed. One page is enough: what is reimbursable, what evidence is needed, the deadline, and the requirement to return advances that weren’t spent.

• Business connection: the expense was paid or incurred while performing services for the company, and would be deductible as a business expense.
• Substantiation: the employee accounts for it to the company within a reasonable period, with the amount, date, place and business purpose, and receipts where required.
• Return of excess: any advance or reimbursement above what was substantiated is returned within a reasonable period.

02What “a reasonable period” means#

The IRS treats certain timeframes as reasonable regardless of the facts: an advance given no more than 30 days before the expense, expenses accounted for within 60 days after they were paid or incurred, and any excess returned within 120 days after the expense. Outside those, reasonableness depends on the circumstances, which is an argument you don’t want to have.

A monthly deadline is simpler and helps the close. If expenses are submitted by the third business day of the following month, the month’s cost is in the books before you review them, and nobody is near the 60-day line.

03When the rules aren’t met#

Payments under a nonaccountable plan are wages. So is any part of a reimbursement the employee didn’t substantiate, and any excess they kept. The company reports it in box 1 of the employee’s Form W-2, withholds income tax, and pays and withholds Social Security and Medicare on it.

The common ways small companies fall into this: a flat monthly allowance for phone or internet with no receipts; reimbursing from a bank transfer with nothing attached; and advances for travel that are never reconciled. Each is easy to fix by attaching the receipt or running the allowance through payroll on purpose.

04Mileage#

For employees driving their own car on company business, most companies reimburse per mile at the IRS business standard mileage rate. For 2026 that rate is 72.5 cents a mile for January 1 through June 30, and 76 cents a mile from July 1, after the IRS raised it mid-year in response to fuel prices. Use the rate in force on the date of the trip.

The rate covers the amount, but the trip still has to be substantiated: date, starting point and destination, miles driven and business purpose. A mileage log or an app that records trips is the evidence. Commuting from home to the employee’s regular workplace is personal, not business mileage, however far it is.

05Sales tax on receipts#

The receipt an employee hands in shows the price of each item, then sales tax, then the total. In the US, sales tax a business pays on its own purchases is generally part of the cost; there is no input credit as there is under a VAT. Reimburse the total and code it, tax included, to the expense account the item belongs to.

The exception runs the other way. If an employee buys something taxable from a seller that didn’t charge tax, typically an out-of-state online seller, the company may owe use tax to its own state on that purchase. The rate and how it is reported are set by each state, so the practical step is to flag untaxed purchases of physical goods when you review expenses and let whoever files your sales and use tax returns decide.

06A worked example: one expense report#

In October an engineer buys desk equipment for the office on their own card: $200.14 of items plus $14.01 of Indiana sales tax at the state’s 7% rate (Indiana has no local sales taxes, so the state rate is the whole rate), $214.15 in total. They also drive 120 business miles to customer sites at 76 cents a mile, $91.20. They submit both on November 2 with the receipt and a mileage log.

When the report is approved, the expense is recorded in October, the month it was incurred, because the books are kept on an accrual basis. Debit side: office supplies $214.15 and travel, mileage $91.20. Credit side: reimbursements payable $305.35. When the reimbursement is paid on November 5: debit side, reimbursements payable $305.35; credit side, cash $305.35. Nothing goes through payroll and nothing appears on the engineer’s W-2.

07Reimbursements or company cards?#

Reimbursement asks employees to lend the company money until the next payment run, which is fine for occasional purchases and unfair for regular ones. Anyone who travels or buys for the company more than once or twice a month should have a company card with a limit. The substantiation rules are the same either way; only who fronted the cash differs.