Whether you run a small business or manage its finances, it’s essential that you understand the differences between reimbursable expenses and taxable income. The IRS is particular when it comes to what may be classified as a reimbursable expense, and penalties can result if you do so improperly. Careful record keeping and maintenance of receipts are essential if your company were ever to be audited.
When you’re providing goods or services for a client, there may be occasions when you assume the cost of an additional service or item out of courtesy to that customer. You may choose not to bill the customer for these costs. If you do, however, the amount would later show up as income in your chart of accounts. Since it is not regular income, there is a need to differentiate.
Anytime you incur expenses on behalf of a client during the course of your work, those costs would fall under the reimbursable expense category. For instance, delivery fees or travel expenses could count as reimbursable expenses. Fuel costs, meals or hotel rooms might also be classified as reimbursable. Under normal business, reimbursement accounting treatment dictates that this is an expense when you incur it and an income item when you bill it to the customer.
If you are a small business and are using a subcontractor, you may have to deal with additional reimbursable expenses called pass-through expenses. For instance, if you are supplying website maintenance services to your client for $500 a month, and you are paying a subcontractor $500 per month to carry out the work, that expense is not income for you, but rather a pass-through expense. You’ll need to provide the subcontractor with Form 1099 at the end of the fiscal year and maintain careful records of what you billed your client and what you paid out for the same work.
When a reimbursement is paid to an employee or the business, it must be properly recorded for it to be considered nontaxable. For instance, on an employee’s pay stub, a reimbursement must be noted as such and not merely included among the employee’s other income. In your business’s chart of accounts, you’ll need to note that it is a reimbursable expense when you first document it. This way, you can cross-check against your income list later to verify that it is not taxable.
Provided the expenses and income line items have been properly documented and tracked, reimbursements are not considered taxable income. You are not getting paid for a good or service in this instance, but rather putting forth a certain amount of money now that is being repaid to you later.
In addition to documenting reimbursable expenses correctly on your chart of accounts, you’ll need to maintain careful records. File all receipts, statements or other documentation relating to the expense if at all possible. Keep a copy with the fiscal year’s tax paperwork so that you can refer to it in the event of an audit or any questions that might arise. Without proper documentation, the IRS could argue that your reimbursable expense should have been treated as taxable income instead, which would lead to your company owing more at the end of the fiscal year.