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How to Reimburse Employees without Creating a Tax Problem

Matthew P Collins

February 9, 2020

How to reimburse employees without creating a tax problem.

Did you know that if an employer reimburses an employee for business entertainment expenses, the reimbursement must be treated as wages per IRC Section 274(a)(1)? That is a bad tax result for both the employer and employee.

The employer must pay payroll taxes on wages paid and the employee is short-changed on the reimbursement by the amount of taxes paid on the reimbursement treated as wages. In addition, under the Tax Cuts & Jobs Act that went into effect on January 1, 2018, employees are no longer able to deduct employee business expenses as a Miscellaneous Itemized deduction.

How can you eliminate this tax problem? Answer - establish an employee business credit card program.

If employees are issued company credit cards and the cards are used for business expenses including entertainment, the company credit card payment is not a reimbursement. Thus, a reimbursement of entertainment expenses is not included in employee wages.

Plus with an employee credit card program, there are additional benefits:

1.      Cashback rewards and travel perks. You should try and pay as much of your business expenses with a credit card to receive the rewards offered by credit card companies. You’re missing out on free money. If you spend $100,000 through a business credit card that provides a 2% reward, with no extra effort on your part you put an extra $2,000 in your pocket.

2.      Credit card programs can reduce the burden associated with paying bills. No more management of receiving vendor bills and employee expense reimbursement requests and issuing paper check payments once the bill is approved. Credit cards are a cost-effective way to pay expenses.

3.      Improved Control – manage your finances and ensure company policy is adhered to with real-time spend controls and user management and vendor level restrictions. Kind of like “parental” control over employee spending.

4.      For businesses that use certain accounting software, like QuickBooks Online, for example, credit card transactions are automatically downloaded into the accounting system for review and posting to the books. This helps simplify the bookkeeping process without negatively impacting control overspending. There are some very good expense reporting software solutions that can integrate with the company’s accounting system that both the employer and employee card user can access to streamline the electronic document management of expense reporting. 

5.      Security – Prevents misuse and theft. Credit cards with embedded microchips provide extra security against fraud.

Before you establish an employee credit card program, you first must address some important issues:

·         Rules for card use

·         Employee requirements for reporting expenses. Your business must clearly define and educate                employees on the importance of having an Accountable plan for payment of business expenses.              An accountable plan means business owners and employees must properly report and support                business expenditures in a timely manner.

·         How rewards earned with employee cards will be shared or used.

·         Eligibility for an employee card

·         When and where employee cards can be used

·         How card violations will be handled

The fact is credit card companies want your business, so it is common for card companies to have built-in tools that can make managing employee purchases easier including such features as the ability to take pictures of receipts, freeze and unfreeze employee cards, set spending limits, expense categorization and digital expense reports.

By taking some time to review and upgrade your current method for reimbursing employees and the process for paying vendors, you will be rewarded by avoiding tax problems for both the employer and employee along with the financial benefits from card reward programs and reduced back-office administration.

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