How to Handle Unreimbursed Employee Expenses

by Jennifer Kiesewetter in September 8th, 2021
woman sitting at table

TLDR

  • Many business-related expenses are deductible on your taxes, such as payroll costs, office rent, business insurance, and marketing costs. The ability to deduct these costs helps offset the expense of starting and running your startup, which positively affects your cash flow and bottom line.
  • Often, especially in the early days of a startup, employees pay for certain business expenses out of their own pockets, hoping to get reimbursed by the company. However, not all employee expenses may be reimbursable. To understand the best way to tackle these issues, it’s best to understand what unreimbursed employee expenses are and how to handle them.
  • According to the Internal Revenue Service (IRS), not all business expenses qualify as unreimbursed work-related expenses. Some examples of allowable costs an employee or a self-employed individual may deduct on their taxes includes business travel, home office expenses, and office supplies.
  • One of the most popular tax deductions is that for mileage. However, the IRS has restricted this available deduction over the last few years.
  • For example, under the TCJA, employees may take deductions for business mileage for those who are self-employed (not W-2 employees), mileage related to traveling to a doctor’s appointment, and mileage incurred while the individual is volunteering for a non-profit organization.
  • The TCJA also altered the deductibility of all unreimbursed employee expenses, effective January 1. 2018.
  • Before the 2018 tax year, and before the passage of the TCJA, employees and self-employed individuals could deduct any unreimbursed work-related expenses as long as they totaled more than 2 percent of their adjusted gross income. If the employee or self-employed individual met this threshold, they could itemize these deductions on their tax forms. To account for these unreimbursed expenses before the 2018 tax year, employees or self-employed individuals needed to include Form 2106 along with their tax filings, identifying each unreimbursed work-related expenditure eligible for a deduction.
  • With the passage of TCJA in December 0f 2017, all unreimbursed employee expenses making up at least two percent of a taxpayer’s adjusted gross income are no longer allowed between the tax years of 2018 and 2025.
  • Post-TCJA, most W-2 employees can no longer document unreimbursed employee expenses on their tax returns. However, for these select groups, they will still need to file a Form 2106 along with their tax filings, identifying each unreimbursed work-related expenditure eligible for a deduction.
  • Self-employed individuals can continue to deduct ordinary and necessary business expenses, offsetting their self-employment income. For these taxpayers, they must report these deductible expenses on Schedule C (Profit or Loss from Sole Proprietorship Business) or Schedule F (Profit or Loss from Farming) of their Form 1040.
  • Note that as a startup founder, you may choose to reimburse some of the expenses above, such as expenses related to business travel. If you reimburse these employee expenses, the employee may not claim them as deductible on their taxes. However, as stated above, you, as a founder, may deduct the reimbursement on your taxes. Check with your accountant on your reimbursement documentation come tax time to take advantage of all available deductions.

When you start a new business, you start incurring expenses, often quickly. These expenses can start adding up for most high-growth startups before you secure investors, especially as you continue to scale.

Luckily, many business-related expenses are deductible on your taxes, such as payroll costs, office rent, business insurance, and marketing costs. The ability to deduct these costs helps offset the expense of starting and running your startup, which positively affects your cash flow and bottom line.

However, what about reimbursing employee expenses? Often, especially in the early days of a startup, employees pay for certain business expenses out of their own pockets, hoping to get reimbursed by the company.

To avoid any confusion, even when you’re just up and running, it’s best to create a policy on which expenses are reimbursable and how to request a reimbursement. And, be sure to keep records on these reimbursements, as the startup can deduct these employee payments on its taxes at the end of the year—yet another deduction boosting your cash flow.

However, not all employee expenses may be reimbursable. To understand the best way to tackle these issues, it’s best to understand what unreimbursed employee expenses are and how to handle them.

What are Unreimbursed Employee Expenses?

Your startup employees may pay for certain business expenses out of pocket. However, not all costs may be reimbursable, based on your startup’s policies and procedures.

And, not all business expenses qualify as unreimbursed work-related expenses, according to the Internal Revenue Service (IRS). Here’s an unreimbursed employee expense list, illustrating examples of which expenses an employee or a self-employed individual may deduct on their taxes:

  • Business travel (does not include commuting expenses)
  • Tools or supplies needed for work, including office supplies
  • Uniforms and other clothing explicitly required for the job
  • Dues as are necessary for professional organizations specifically related to the job
  • Continuing educations costs, such as seminar or training costs
  • Business insurance premiums, including business liability or malpractice coverage
  • Home office expenses (based on its square footage)
  • Business meals (only 50% of the cost of the meal may be deducted)

Note that as a startup founder, you may choose to reimburse some of the expenses above, such as expenses related to business travel. If you reimburse these employee expenses, the employee may not claim them as deductible on their taxes. However, as stated above, you, as a founder, may deduct the reimbursement on your taxes. Check with your accountant on your reimbursement documentation come tax time to take advantage of all available deductions.

Unreimbursed Employee Expenses Mileage

One of the most popular tax deductions is that for mileage. However, the IRS has restricted this available deduction over the last few years. So, it pays to know the rules.

Passed in December 2017, the Tax Cuts and Jobs Act (TCJA) altered how Americans can take deductions on their taxes. The law eliminated itemized deductions for many unreimbursed expenses, such as those related to mileage expenses, and further limited which mileage deductions may be taken.

For example, under the TCJA, employees may take deductions for business mileage for those who are self-employed (not W-2 employees), mileage related to traveling to a doctor’s appointment, and mileage incurred while the individual is volunteering for a non-profit organization.

For self-employed individuals, they can claim a 57.5 cent deduction per mile for their 2020 tax filings. However, for the 2021 tax year, the amount of the deduction reduces to 56 cents per mile. When deducting mileage related to working for a charity, the deduction for 2020 is 14 cents per mile; this deduction amount remains the same for the 2021 tax year. Finally, the deduction is 17 cents per mile for the 2020 tax year and 16 cents per mile for the 2021 tax year for driving to medical appointments.

Note that for mileage related to medical appointments and treatments, the mileage deduction may only be taken if both your applicable mileage and medical bills exceed 7.5 percent of your adjusted gross income. If you do not exceed this threshold, you cannot take the mileage deduction for medical care. No threshold exists for charity work or business mileage.

Neither employees nor self-employed workers may take a mileage deduction for commuting from home to the workplace. Further, suppose the individual uses the same car for both business and personal needs. In that case, only those related to business, medical, or volunteering activities (as specified in the tax law) may be deducted.

If you are eligible to take a mileage deduction, be sure you keep documentation on your relevant mileage. In addition, you should keep a running log of your deductible mileage, which can be challenging to be accurate (or even remember to do so) if you’re recording your automobile trips by hand. Luckily, numerous mileage tracking apps exist, including MileIQ and Quickbooks Online, helping you keep accurate records while importing the information into your accounting system.

Can I Deduct Unreimbursed Employee Expenses on My Taxes?

Like the mileage deduction, the TCJA also altered the deductibility of all unreimbursed employee expenses, effective January 1, 2018. Let’s examine how unreimbursed employee expense deductions were taken before the TCJA and then after.

Deduction Taken Before the TCJA

Before the 2018 tax year, and before the passage of the TCJA, employees and self-employed individuals could deduct any unreimbursed work-related expenses, as long as they totaled more than 2 percent of their adjusted gross income. If the employee or self-employed individual met this threshold, they could itemize these deductions on their tax forms.

Before 2018, these unreimbursed employee expenses did not have to be required expenditures by the employer but needed to be common and appropriate for the job or business.

To account for these unreimbursed expenses before the 2018 tax year, employees or self-employed individuals needed to include Form 2106 along with their tax filings, identifying each unreimbursed work-related expenditure eligible for a deduction.

Deduction Taken After to the TCJA

With the passage of TCJA in December 0f 2017, all unreimbursed employee expenses making up at least two percent of a taxpayer’s adjusted gross income are no longer allowed between the tax years of 2018 and 2025.

As such, post-TCJA, most W-2 employees can no longer document unreimbursed employee expenses on their tax returns. Only a small number of protected groups can still take advantage of this deduction., including Armed Forces reservists, qualified performing artists (note, this group is narrowly defined), fee-basis state or local government officials, and employees with impairment-related work expenses. Each of these categories is explained in detail in IRS Publication 529.

For these select groups, they will still need to file a Form 2106 along with their tax filings, identifying each unreimbursed work-related expenditure eligible for a deduction.

Note that self-employed individuals can continue to deduct ordinary and necessary business expenses, offsetting their self-employment income. For these taxpayers, they must report these deductible expenses on Schedule C (Profit or Loss from Sole Proprietorship Business) or Schedule F (Profit or Loss from Farming) of their Form 1040.

For the 2026 tax year, all miscellaneous itemized deductions, including unreimbursed employee expenses, shall be reinstated for all employees—unless Congress decides to extend the tax law’s applicability.

Finally, when filing your taxes, be sure to consult with an experienced accountant in your state, as you may be able to deduct certain work-related expenses on your state income tax return.

Can My Startup Deduct Reimbursed Employee Expenses?

Businesses of any size, including startups, can take advantage of tax deductions if they reimburse their employees for work-related expenses incurred. By keeping documentation on these reimbursements, founders can lower their taxable income come tax time. When starting a new business, every penny counts.

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