What is the difference between payroll allowances and reimbursements?

Employees often have out-of-pocket expenses that require reimbursement, and ensuring they have a simple and easy-to-use system to facilitate reimbursements is necessary for businesses of all sizes.

What is the difference between payroll allowance and reimbursement?

A popular question from business leaders and employees is about the difference between reimbursements and allowances.

The first difference involves timing.

A payroll allowance is typically used for future expenses or purchases, while an employee reimbursement is used for expenses which have already been incurred.

The second difference involves the tax treatment of both.

Payroll allowances are often subject to payroll taxes as the allowance is part of the employee's pay package. This is a key point, as payroll taxes affect both the employer and the employee.

Since the employer must collect payroll taxes from employee wages, payroll allowances must be classified correctly.

Do you get taxed on expense reimbursements?

Another popular question is whether employees are taxed on reimbursements.

Typically, companies reimburse employees for business-related expenses paid from their own funds. And if the business expense is deductible, the reimbursement won’t be taxed.

Business-related expenses are deductible if they’re "ordinary and necessary" for the business's day-to-day operations. And as employers ordinarily do not reimburse employees for non-business-related expenses, it is rare to find a reimbursement that will be taxed.

What are the three common types of reimbursement?

Qualified business expenses

Ordinary and necessary tax-deductible business expenses describe an expense that helps a company make money and is typical for the industry. For example, printer paper used by the company office qualifies as deductible, and any reimbursements made to an employee for purchasing printer paper will be tax deductible.

Travel reimbursement

Travel reimbursements can include airfare as well as mileage reimbursement. Think of this as a subset of the qualified business expense deductions. For the mileage reimbursement, standard mileage rates apply to calculate the reimbursement amount.

What is the IRS policy for expense reimbursement? The IRS sets a standard reimbursement rate per mile (30 cents for 2024), and this rate is multiplied by the distance traveled to calculate the total reimbursement amount.

At Payhawk, we have a robust application that streamlines mileage calculation, making it easier for both employers and employees to process reimbursements.

Employers can also give a per diem amount for travel which they can set per country or even per city. In this case, the employee needs to return any unused travel funds to avoid being taxed on any excess funds.

Medical expense reimbursement

Many employers in the USA also offer some health benefits, whether paying employee insurance or other methods. Medical reimbursements are gaining popularity as they provide more flexibility for employees while still allowing employers to deduct amounts as business expenses.

Medical expense reimbursement plans (MERPs) let employees choose their own health benefits, and expenses incurred are reimbursed by their employer while being tax deductible.

Employee stipends

Employee stipends are another way companies offer more flexibility to their employees to choose their benefits. Examples of employee stipends are education, wellness, and health. The tax treatment of employee stipends is a bit more complicated than the reimbursement discussed above, as the IRS may classify the stipend as employee income depending on what funds are used.

The stipend is likely fully deductible as a fringe benefit if the employer is a corporation. If the employee uses the stipend for company purposes, it will not be taxed. However, if the employee keeps the stipend for personal use, the IRS will likely classify it as income and subject to taxation.

The IRS tends to look closely at reimbursements to ensure they are classified correctly. Remember that payroll allowances are typically subject to payroll taxes as they are part of an employee's wages. Ensuring accuracy is the best way to avoid an IRS letter or penalties.

Best practices for managing allowances and reimbursements

Why would an employee fill out a reimbursement form?

Proper documentation is an essential part of any reimbursement procedure. A legacy process would involve an employee incurring an expense and filling out a reimbursement form to receive payment from their employer. According to the IRS, this should be done within 60 days of the transaction.

However, with solutions like Payhawk, employees can complete the above in seconds via the app.

All employees need to do is:

• Take a photo of their receipt and upload it
• The in-built OCR technology will automatically capture all of the receipt data.
• Employees then choose a spend category from a dropdown list created by the finance team (in collaboration with the budget owners) to allocate all spend to the appropriate category
• The finance admin or manager can then see the spend in real-time, what it was for, and approve or decline it for payment in seconds

By doing the above, employees will have digitized the receipts that back up the transaction so the company will have the correct information to reimburse them quickly, and as evidence for future tax deduction purposes.

Why use a spend management solution like Payhawk instead of payroll reimbursement?

As per the above, at Payhawk, our expense management software includes automated data capture and automatic receipt tracking. This eliminates the need for manual tasks and reduces the risk of losing receipts or losing track of expenses. We help employees save time and swerve being left out of pocket by avoiding approval delays and lengthy reimbursement requests through emails, too. They can simply make a purchase, enter the receipt using the platform, and receive instant reimbursement through the mobile app.

Alternatively, companies could choose to use our corporate credit cards instead. Here, employees pay with Payhawk corporate visa cards (with in-built spend controls, like limits and blocks), directly linked to our expense management software and funded according to their budgets. This eliminates the need for reimbursements altogether.

Furthermore, employing an innovative solution like ours offers more advantages compared to traditional payroll expenses:

• Employers and managers no longer have to wait until the last minute before payroll to receive expense reports
• Employees find it easy to enter the required information, submit it, and carry on with their day
• Employees aren't left out of pocket
• Payhawk integrates smoothly with major accounting software providers such as Xero and QuickBooks. As well as popular ERP solutions like NetSuite and Microsoft Dynamics. This seamless integration and instant data synchronization are reasons why finance teams worldwide trust Payhawk to streamline expense management

What's next?

In the current fast-paced business environment, finance teams require more efficient methods for managing employee expenses. By adopting spend management solutions like ours, businesses can overcome the challenges and disadvantages of processing expenses through payroll.

Interested in learning more? Schedule a demo today, and let's discuss seamless expense management.