Here is a number that will make you wince. A typical organization loses about 5% of its revenue each year to occupational fraud. That is real money walking out of the door and frankly, tracking employee reimbursement correctly is one of our best defenses against this kind of loss while keeping the tax folks happy.
What Employee Reimbursements Are and Why They Matter:
Employee reimbursement are pretty straightforward. You are paying employees back for business expenses they covered with their own money. It can include travel costs, office supplies, client dinners and training courses.
But here is where it gets interesting. How we handle these reimbursements affects everything from tax treatment to cash flow management. The IRS has specific rules about this stuff and when we get it right, both employers and employees can avoid extra tax headaches. If you miss the mark, those reimbursements become taxable compensation. Nobody wants that surprise.
The IRS maintains detailed guidance about accountable plans and proper expense procedures and honestly, it’s worth getting familiar with. Here it is: IRS
For business perspective, reimbursements tracking touches multiple areas. Cash flow planning gets more accurate when you can predict expense timing.
The external auditors usually scrutinise reimbursement practices as part of their control evaluation so in this case, poor tracking can signal broader accounting issues that can invite unwanted attention.
Accountable Plan vs Non-Accountable Plan Requirements:
The IRS has three basic requirements for what they call an “accountable plan”. It is the kind that allows tax-free reimbursement. Expenses need a business connection, which is pretty obvious. Then the employees must provide adequate proof within a reasonable timeframe which includes receipts, dates, and business purposes and any excess advances need to be returned promptly.
Read more about it here: IRS
When arrangements don’t meed these standards, the IRS treats them as “non-accountable plans”. It means, those reimbursements become taxable wages. Subject to income tax withholding, payroll taxes, W-2 reporting and the whole nine yards.
Employees lose the ability to deduct business expenses unless they itemise and jump through additional hoops. Employers face higher payroll taxes and more administrative complexity.
The bookkeeping consequences go beyond tax treatment though. We have to process reimbursements through payroll instead of accounts payable, creating delays and extra steps. Poor documentation makes expense categorisation very less reliable. This affects financial reporting and budget analysis. Non-accountable arrangements also can also increase adit risk, which you have to avoid no matter what.
Recordkeeping and Documentation Requirements:
Documentation is everything here. The IRS wants specific proof for different business expenses. It includes original receipts showing amount, date, place and business purpose. For travel, employees need to document time, place, business purpose, plus business relationships when entertaining clients. When it comes to being on the road, mileage reimbursements should include detailed logs with dates, destinations, purposes and odometer readings.
Read more about it here: IRS
Organizations typically need to keep these records for 3 years for filing the related tax return and sometimes it can be longer. Certain circumstances can extend this to 6 years or more. Some states require employers to reimburse remote employees for necessary business expenses such as home office costs, internet and phone bills. California and Illinois have specific statutes that may exceed federal requirements. We have to navigate both federal tax rules and state labor laws and they don’t always play nicely together. An arrangement that satisfies IRS requirements might still violate state reimbursement mandates if they employer does not cover required expenses. Remember, we have to navigate both federal tax rules and state labor laws and they don’t always play nicely together.
How to Record Reimbursements in Your Books:
Before we get into this, it completely depends on whether you have got an accountable or non-accountable plan. Under an accountable plan, we record the actual business expenses in their proper categories rather than as employee compensation. When employees submit expense reports properly, we record business expenses and process reimbursements through accounts payable and not payroll.
This approach has clear advantage though. Expenses appear where they belong on income statements. The reimbursement process should stay separate, we repeat, separate from payroll because this reduces complexity and potential errors.
Professionally, we recommend you to match the reimbursements to documented expenses and maintain clear audit trails. The journal of Accountancy provides detailed implementation guidance for accountable plans and proper bookkeeping practices.
Non-accountable plans require completely different treatment. These reimbursements must always go through payroll as taxable wages, with proper withholding and reporting. The underlying expenses can still be deductible business expenses. But they’re recorded separately from wage payments. This creates additional reconciliation work and complicates financial statement preparation.
Internal Controls and Fraud Prevention:
Here’s something that might surprise you completely. Expense reimbursements are actually a pretty common way for employees to steal from their employers. They do it by fake receipts, inflated amounts, personal expenses disguised as business expenses.
The good news is most of this stuff is preventable with basic internal controls. get your expense reports reviewed by someone other than the person submitting them. But you would be amazed how many small businesses skip this step. Have different people handle approvals and payments. So, don’t let them same person control the whole process.
Watch the patterns. Employee consistently spending exactly $24.99 on meals? It’s a red flag. Same person always losing receipts, a major red flag. The expenses that don’t make sense for someone’s role, you have guessed it.
Regular audits help too, even the informal ones. Just spot checking a few expenses reports every month can catch problems before they get expensive.
Staying Organized Before the Auditors Show Up:
Monthly reconciliation is your friend here. Make sure approved reimbursements actually got recorded properly. Make sure your expense accounts make sense. Make sure anything that went through payroll got taxed correctly.
Keep good records. We mean really good records. Digital is fine and actually, digital is better because you can search and sort and not lose things. But whatever system you use, make it consistent and make it complete.
When auditors show up (and they will eventually), they’re going to want to see how you handle reimbursements. Clean records, clear policies, consistent processes are the things make audits shorter and cheaper.
Common Ways to Mess This Up:
We have seen all the classics. Treating legitimate reimbursement as wages because someone did not understand the accountable plan rules. Accepting credit card statements instead of actual receipts. Trust us, the IRS hates this. Taking forever to reimburse people, which can violate federal and state reimbursements.
Ignoring state rules is a big one, especially with remote work becoming more common. Mixing personal and business expenses on the same report. Letting advances pile up without resolution. The thing is, most of these mistakes are totally avoidable if you just set up proper systems from the beginning.
Technology Can Actually Help:
Modern expense management systems can automate a lot of this headache away. Built-in policy checks, automatic approval workflows, digital receipt capture. It’s all there if you want it. The systems can flag weird expenses, require proper documentation, and keep audit trails automatically. Integration with your accounting software like MagicBooks means less manual data entry and really fewer chances for errors.
Recent studies have shown that companies using automated systems have really fewer payroll mistakes and better tax compliance. The Journal of Accountancy has documented significant improvements for companies that invested in good expense automation.
Cloud-based systems such as MagicBooks are especially nice because they automatically update tax rates and regulations without you having to think about it.
Bottom Line:
Look, this isn’t the most exciting topic in the world, but getting reimbursements right can save you serious money and headaches. Set up proper accountable plans, require good documentation, maintain decent controls, and stay current with the rules.
Do it right from the start, and you won’t be one of those businesses frantically calling their accountant in January because something went wrong with their reimbursements.
