Expense Reimbursement: Accountable Plans and State Rules

Employers can reimburse business expenses tax free only through an IRS accountable plan: the expense must be business related, substantiated within a reasonable period, and any excess returned. Anything else is taxable wages. Separately, states such as California, Illinois, Iowa and New Hampshire require reimbursement, and the FLSA bars costs that cut pay below minimum wage.

Key takeaways

• An accountable plan needs three things: a business connection, adequate accounting within a reasonable period, and return of any excess.
• The IRS business standard mileage rate for 2026 is 72.5 cents per mile.
• Payments under a nonaccountable plan are wages subject to income tax withholding, Social Security, Medicare and FUTA.
• Under the FLSA, unreimbursed required expenses that push pay below minimum wage are an illegal kickback.

What makes an expense plan "accountable" under IRS rules?

The IRS describes the test in Publication 15 (Circular E) for employers and in Publication 463 for travel, gift and car expenses. To be accountable, the arrangement must require all three of the following:

1. Business connection. The employee incurred allowable expenses while performing services for you, and the payment is not disguised wages.
2. Substantiation. The employee adequately accounts for the expense (amount, date, place, business purpose) within a reasonable period.
3. Return of excess. The employee returns any amount above substantiated expenses within a reasonable period.

Amounts paid under an accountable plan are not wages and are not subject to income tax withholding, Social Security, Medicare or FUTA, according to Publication 15. If an employee fails to substantiate or return the excess, that excess is treated as paid under a nonaccountable plan and becomes taxable in the first payroll period after the reasonable period ends.

What counts as a "reasonable period"?

Publication 463 lists safe harbor timelines that the IRS will always treat as reasonable:

Action	Safe harbor timing
Employee receives an advance	Within 30 days of when the expense is incurred
Employee substantiates the expense	Within 60 days after it was paid or incurred
Employee returns any excess	Within 120 days after the expense was paid or incurred
Periodic statement method	Employer sends a statement at least quarterly; employee returns or accounts for advances within 120 days of it

Build these deadlines into your policy and expense software reminders. A policy with no submission deadline can fail the reasonable period test.

What is the IRS mileage rate for 2026?

The IRS set the 2026 business standard mileage rate at 72.5 cents per mile, effective January 1, 2026, up 2.5 cents from 2025. The rate applies to gasoline, diesel, electric and hybrid vehicles. Under Publication 15, mileage reimbursements up to the standard rate under an accountable plan are exempt from withholding and employment taxes, while amounts above the federal rate are taxable wages.

You do not have to pay the IRS rate. It is a tax safe harbor, not a federal pay mandate. But paying less can create problems under state reimbursement laws if it does not cover actual costs, and under the FLSA for low-wage drivers. Some employers use a fixed and variable rate (FAVR) allowance instead, with limits set in an annual IRS notice.

How are nonaccountable plan payments taxed?

A flat car allowance or an unsubstantiated phone stipend is a nonaccountable plan. Publication 463 says the employer combines these payments with wages and reports the total in box 1 of Form W-2. They are subject to federal income tax withholding, Social Security, Medicare and FUTA, and they flow into your deposit obligations under the rules in our guide to payroll tax deposit schedules.

Two traps catch employers. First, paying expenses by reducing reported wages is nonaccountable, because the employee would get the full amount anyway. Second, most employees cannot deduct unreimbursed employee expenses, as the IRS notes in its 2026 mileage announcement, so a taxable stipend costs them more than it appears. Taxable allowances are also generally treated as remuneration for overtime purposes, so check how they interact with the FLSA regular rate for nonexempt staff.

Which states require employers to reimburse expenses?

Federal tax rules say how to treat a reimbursement; state labor laws decide whether you owe one. These four are verified against statute text. Other states have similar rules, so check each state where you employ people.

State	Statute	Core rule
California	Labor Code 2802	Indemnify employees for all necessary expenditures or losses incurred in direct consequence of their duties. Awards carry interest and attorney's fees.
Illinois	820 ILCS 115/9.5	Reimburse necessary expenditures within the scope of employment. Employees submit within 30 calendar days unless a written policy allows more. Policies can set limits but not zero or de minimis reimbursement.
Iowa	Iowa Code 91A.3(6)	Reimburse authorized expenses in advance or within 30 days after the employee submits a claim. Refusals must be explained in writing.
New Hampshire	RSA 275:57	Reimburse expenses incurred at the employer's request within 30 days of proof of payment, except costs borne as a condition of getting the job.

California is the broadest. Labor Code 2802 does not require the employer to have approved the expense in advance, only that it was necessary. Iowa, by contrast, covers expenses the employer authorized. When employees work in several states, expense policy belongs on the same compliance map you use for multi-state payroll and conflicting tax rules.

Do you have to pay for remote workers' phones and internet?

Federal tax law does not require it; some state laws do. California courts read Labor Code 2802 broadly: in Cochran v. Schwan's Home Service (2014), the California Court of Appeal held that when employees are required to use personal cell phones for work, the employer must reimburse a reasonable percentage of the bill, even if the plan is unlimited and the employee's cost did not increase. Many employers apply the same logic to home internet when remote work is required.

A practical structure for remote and hybrid staff:

• Decide what is required. Required phones, internet or equipment are far more likely to be reimbursable necessary expenses.
• Choose accountable or taxable. A flat stipend is simple but taxable. A substantiated reimbursement (a bill plus a stated business use percentage) can be tax free.
• Set the amount by state. A stipend reasonable elsewhere can fall short of California's "all reasonable costs" standard.
• Write it down. Illinois gives weight to a written policy, and so does your accountable plan.

Our guide to managing a remote workforce legally in the US covers other state obligations that follow remote staff.

How can unreimbursed expenses violate minimum wage law?

The FLSA requires wages to be paid "free and clear." Under the Department of Labor regulation at 29 CFR 531.35, if an employee must return part of their wages to the employer, directly or indirectly, the minimum wage is not met. The regulation's own example: when an employer requires employees to provide tools of the trade, a violation occurs in any workweek where those costs cut into the required minimum or overtime wages.

This matters most for drivers, field technicians and hourly remote staff paid near minimum wage. A driver at the federal minimum using a personal car without mileage reimbursement may fall below it once vehicle costs are subtracted. Review expense shortfalls before a DOL wage and hour investigation does it for you.

How to apply this: a worked example

Consider a hypothetical 300-person distributor with sales reps in California, Illinois and Texas who use personal cars and phones. Each gets a flat 400 dollar monthly car allowance and nothing for phones.

1. Tax status. The flat allowance is a nonaccountable plan, so payroll confirms it is in box 1 and subject to withholding.
2. Switch to accountable mileage. Reps log business miles in the expense tool within 60 days, and the company reimburses at 72.5 cents per mile. Reimbursements up to that rate are tax free.
3. Phones. Phone use is required, so the company reimburses a stated business percentage of each bill, in all three states for consistency.
4. Illinois policy. The written policy states the submission window and limits, with no category at zero.

Common mistakes

• Calling a flat stipend "reimbursement" and leaving it off the W-2.
• No submission deadline, so the plan never meets the reasonable period test.
• Ignoring phones and internet for required remote work in California.
• Letting tool or vehicle costs push hourly pay below minimum wage.

Frequently Asked Questions

Is the IRS mileage rate mandatory for employers?

No. Federal law does not require you to reimburse mileage at the IRS rate. The rate is a safe harbor: reimbursements up to it under an accountable plan are tax free. State laws such as California Labor Code 2802 can require you to cover actual reasonable costs, and the FLSA can require enough to keep pay at minimum wage.

Can a stipend be part of an accountable plan?

Only if employees substantiate the expenses and return any excess. A fixed monthly amount paid regardless of actual spending is nonaccountable and taxable. A common alternative is a capped reimbursement: employees submit their bill and business use percentage, and you pay the documented amount up to a stated limit.

How long do employees have to submit receipts?

For the IRS safe harbor, substantiate within 60 days after the expense. Illinois sets a default of 30 calendar days unless your written policy allows longer. Use the shorter window where it applies, and send reminders so employees do not miss it.

Are reimbursements included in the regular rate for overtime?

Genuine reimbursements of business expenses incurred for the employer are generally excluded from the FLSA regular rate. Flat allowances that do not reasonably track actual expenses may be treated as pay and included. Tie reimbursements to documented costs.

Next steps for payroll and HR

• Audit every allowance and stipend and label each as accountable or nonaccountable.
• Add 60 day substantiation and 120 day return deadlines to your written policy.
• Update mileage reimbursement to the 2026 rate if you use the IRS rate.
• Map reimbursement statutes for every state where you have employees.
• Confirm required expenses never drop hourly pay below minimum wage.

For related payroll guidance, see the payroll compliance guides hub.

Last reviewed: October 2026.

Sources

• Publication 463: Travel, Gift, and Car Expenses, Internal Revenue Service
• Publication 15 (Circular E), Employer's Tax Guide, Internal Revenue Service
• IRS sets 2026 business standard mileage rate at 72.5 cents per mile, Internal Revenue Service
• 29 CFR 531.35: "Free and clear" payment; "kickbacks", eCFR