8754 / How does an employer’s reimbursement or failure to reimburse an employee’s expenses impact a taxpayer’s business expense deductions?

The tax treatment of an employee’s business expenses depends on whether the employee is reimbursed for them by the employer. The IRC provides that expenses paid or incurred by the taxpayer, in connection with the performance of services as an employee, under a reimbursement or other expense allowance arrangement with the employer are deductible in full from gross income, to arrive at adjusted gross income, so long as the expenses otherwise qualify as business expense deductions.¹ Generally, this deduction will be available only to the extent that the reimbursement is includable in the employee’s gross income.²

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Planning Point: In some jurisdictions (California and Illinois, for example) employers are required to reimburse employees for employment expenses. This may create the need for employers to reimburse employees for the cost of maintaining a home office. Further, the FLSA does not permit an employer to require an employee to pay for business expenses if doing so would reduce the employee’s earnings to below the minimum wage. However, simply providing cash reimbursement may generate additional taxable income for the employee. The miscellaneous itemized deduction for expenses incurred in the “trade or business of being an employee” was suspended for 2018-2025. Employers may instead wish to consider a program where the employer leases or purchases the required equipment for the employee’s use.

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Employers are generally required to report certain employee reimbursements for business expenses on Form W-2. The reporting requirements apply to the following groups:

(1)  employers who do not require substantiation (or whose employees fail to substantiate expenses);

(2)  employers who advance amounts for expenses and do not require the return of (or do not receive) unused amounts; and

(3)  employers who reimburse a per diem or other fixed amount that exceeds government specified rates.

The rules, thus, generally apply only to reimbursements for unsubstantiated expenses and unreturned excess amounts.³

It is not uncommon for an employee to incur expenses in connection with work that are not reimbursed by the employer. Examples include an employee’s use of his own automobile or subscriptions to work-related professional journals. Prior to 2018, the same business expenses that are deductible by a self-employed person are deductible if incurred by an employee, but in the case of an employee, the deduction is allowable only as an itemized deduction. As such, it is treated as a so-called “miscellaneous itemized deduction.”⁴ Miscellaneous itemized deductions are allowed only to the extent that the aggregate of such deductions exceeds 2 percent of the taxpayer’s adjusted gross income.⁵ Note that all miscellaneous itemized deductions subject to the 2 percent floor were suspended for 2018-2025.

An employee cannot choose to forego reimbursement for a business expense for which his employer would pay and claim a deduction. “[A] business expense deduction is not allowable to an employee to the extent that the employee is entitled to reimbursement from the employer for an expenditure related to his status as an employee.”⁶