How to Show Out-of-Pocket Expenses on a Pay Stub

Out-of-pocket expenses are a broad term that encompasses various types of expenditures that may or may not be reimbursed later. In the context of employer-employee relations, these expenses refer to job-related payments that workers make with their own money, which employers may reimburse later.

In this article, we’ll explore the meaning of out-of-pocket expenses, the way they are recorded for payroll and on pay stubs, why they are important, and what tax implications surround them. We’ll also go through some common mistakes to avoid when it comes to out-of-pocket expenses, and show you how to use our software to simplify reporting and record-keeping.

Key Takeaways

• Out-of-pocket expenses in business refer to any expenditures that employees incur personally, which may be reimbursed by their employers later.
• Common examples of these expenses include airfare, lodging, and meal costs when traveling, gas, tolls, insurance for using a personal vehicle, office equipment for remote employees, and expenses related to professional development.
• Out-of-pocket expenses are tax-free only if they are reimbursed under an accountable plan, which means they must be related to work, substantiated with receipts, and reported in a timely manner.
• You can effortlessly track and record out-of-pocket expenses on pay stubs using our document generator at Paystub.org.

What Are Out-of-Pocket Expenses?

In business, out-of-pocket expenses cover a wide range of work-related costs that employees pay using their personal funds. In essence, the employees are essentially fronting the money needed to keep the business operations going, which will later be reimbursed by their employers.

Businesses typically have clearly defined employee expense reimbursement policies to outline what expenses qualify for reimbursement. A clear policy is essential as there are many different types of out-of-pocket expenses, and employers typically don’t cover all of them.

Common Examples of Out-of-Pocket Expenses

Out-of-pocket expenses vary depending on the nature of the job and the company’s policy.

Some of the most common examples of out-of-pocket expenses include travel-related payments, such as:

• Airfare
• Lodgings
• Car rentals
• Public transportation fares

Meal costs (either just for employees or for client meetings, as well)

Other costs are associated with using a private vehicle for business purposes, and include:

• Gas
• Tolls
• Tires
• Insurance
• Registration
• Car repairs
• Lease payments or depreciation

It’s important to note that out-of-pocket expenses for vehicle use usually don’t cover the everyday commute to and from an office.

Following that, there are common out-of-pocket office supply and tools expenses, typical for remote employees, such as:

• Paper
• Printer ink
• Stationery
• Software subscription
• Various hardware

Finally, there are out-of-pocket expenses associated with professional development, and they include:

• Tickets and fees for conferences and seminars
• Costs of training courses and certifications
• Memberships in professional organizations

Where Do They Appear on Pay Stubs?

When employees incur out-of-pocket expenses, they’ll be reflected on their pay stubs, usually as a separate line item from their standard wage, to ensure clarity.

Here are several different ways of highlighting out-of-pocket expenses on a pay stub:

• In a dedicated reimbursement section. Many employers create pay stubs with a dedicated section for reimbursement titled “Reimbursements” or “Expenses.” This makes it easy to distinguish them from regular, taxable earnings.
• Under another general category. Some pay stubs don’t have a section designated explicitly for out-of-pocket expenses, but they can be bundled with other miscellaneous types of income.
• As an item or a list in the earnings section. In some cases, employers will add reimbursements for out-of-pocket expenses to the standard earnings section, with a specific line for each type of reimbursement.

How to Record Out-of-Pocket Expenses for Payroll

Learning how to record out-of-pocket expenses is crucial for maintaining accurate payroll reimbursements and legal compliance. Having robust systems in place ensures that employers can compensate their workers adequately while accurately recording all transactions for accounting purposes as well as tax and payroll compliance.

#1. Establish a Clear Expense Policy

The first step in maintaining clear records for your out-of-pocket expenses for payroll is having a comprehensive and easy-to-understand policy. This policy needs to clearly define what the company will reimburse and in what amounts.

Moreover, the policy should provide clear instructions on how to document and report expenses. This includes having defined timelines for submitting these reports. This helps avoid confusion and prevent delays. Plus, referring to the policy can help resolve most issues that arise in the future.

#2. Document and Report the Expense

The employee’s main responsibility is to document the expenses meticulously and report them appropriately. This involves keeping track of every business-related expenditure and collecting receipts for every purchase.

For instance, if an employee went for a business trip using their car, they’d keep a detailed log with dates, destinations, mileage, and the purpose of the trip. Furthermore, they’d add the cost of meals and lodging, as well as additional expenses for client-related purposes.

Submitting an expense report involves using the correct channels and documentation to compile all the necessary information in accordance with the policy. Most businesses use digital tools, mobile apps, and templates that enable employees to upload receipts and fill in the necessary forms, allowing for streamlined reporting.

#3. Managerial Review and Approval

After a report is submitted, it typically needs to be reviewed by an authorized person or department within the company. This can be anyone, from the employer in a smaller company to the employee’s direct manager in large organizations.

The person in charge is responsible for reviewing the report and all the submitted documentation to ensure its validity. The goal is to verify if the expenses are eligible for reimbursement and if they fall within the company’s policy guidelines.

This is a critical step in preventing mistakes that can escalate into larger problems, disputes, and even legal issues.

#4. Record Reimbursement in the Payroll System

After the review and approval, the reimbursement needs to be entered into the payroll system. This is typically handled by the company’s HR or finance department and is a crucial step in expense tracking for payroll.

Companies often use specialized payroll software for these purposes. These are systems that allow for automation, separating reimbursed amounts from regular, taxable income, provided that reimbursements fall under IRS-defined accountable plans.

#5. Classify and Process the Expense

Finally, the employer classifies each expense for accounting purposes and processes the transactions. This is particularly important in large companies or organizations that regularly encounter various types of out-of-pocket expenses.

Proper classification helps track the budgets of different departments, allowing companies to accurately calculate and deduct business expenses when filing tax returns. Moreover, that makes it easier to add out-of-pocket expenses to an employee’s pay stub, providing them with a clean and transparent record.

Why Are Out-of-Pocket Expenses Important?

Out-of-pocket expenses are important for multiple reasons, benefiting both the company and its employees. It’s not just a financial tool but a way to foster goodwill among employees, improve company culture, and create stronger interpersonal relationships while ensuring tax compliance.

For employees, timely reimbursement for out-of-pocket expenses ensures they don’t feel the financial strain of spending personal money for business purposes. That’s why it’s essential to have transparent and efficient policies. Otherwise, employees may have to wait longer than necessary to have their expenses covered, which can negatively impact their morale.

Employers need to accurately track out-of-pocket expenses and reimbursements for internal financial records and tax purposes. When companies reimburse legitimate business expenses to employees, they become tax-deductible. On the other hand, accurate tracking can prevent fraudulent claims or unnecessary spending.

Finally, it’s critical to properly record and classify out-of-pocket expenses to distinguish between taxable and non-taxable income. When companies properly reimburse their workers under an accountable plan, utilizing adequate reporting channels, the income doesn’t become taxable for employees.

On the other hand, misclassification can result in unnecessary taxes that can reduce the employee’s take-home pay or hurt the company’s finances. Additionally, classifying taxable income as non-taxable reimbursements and failing to withhold taxes can lead to financial and legal repercussions that escalate with the severity of the offense.

IRS Rules for Expense Reimbursements

The IRS has specific rules to help businesses determine whether employee expense reimbursements are taxable or not. The primary distinction lies in whether the reimbursement is made under an accountable or a non-accountable plan.

Any reimbursements for out-of-pocket expenses that an employer pays to their employee under an accountable plan are excluded from the employee's gross wage and are not taxable.

However, these expenses need to satisfy these three criteria:

1. The expense must have a clear connection to the business and be incurred specifically while the individual is working for the company.
2. The employee must substantiate the expense within a reasonable time by providing the necessary receipts and records.
3. Any excess that has been reimbursed but not used as an out-of-pocket expense must be returned within a reasonable time period.

If a reimbursement satisfies all three of these criteria, it won’t be counted as a wage and will not be reported on an employee’s Form W-2, as it is not subject to tax withholding.

However, if a payment fails to satisfy even one of the IRS accountable plan rules, it falls under a non-accountable plan and is considered taxable income.

For instance, if the employer provides their employee with a flat monthly amount for expenses without requiring documentation, that income is subject to tax withholding and must be included on the employee’s Form W-2.

3 Common Mistakes to Avoid With Out-of-Pocket Expenses

Before we wrap up, let’s examine the three most common mistakes that both employers and employees make regarding out-of-pocket expenses.

#1. Submitting Incomplete or Late Expense Reports

One of the most common mistakes employees make when seeking reimbursements is submitting expenses late or without all the necessary documentation. Missing some of the receipts or not being able to substantiate the purchase and explain their connection to the business can lead to a rejection of a reimbursement claim.

Having clear policies with set deadlines and straightforward reporting guidelines helps prevent mistakes and unnecessary backlogs of claims.

#2. Using Personal Purchases as Business Expenses

Personal purchases that aren’t related to business operations can’t be claimed as expenses for tax-free reimbursement. Attempting to do so is a serious offense that can even be considered a form of fraud.

That’s why it’s essential for employees to understand which expenses are personal and separate them from business costs. The companies should also have robust review systems in place to verify claims and protect themselves from being held liable for tax fraud.

#3. Not Differentiating Taxable Vs. Non-Taxable Reimbursements

One of the biggest mistakes employers can make when reimbursing their employees is to classify taxable reimbursement as non-taxable. If an employee cannot demonstrate a clear business connection to their expenses or provide receipts, reimbursing them without withholding taxes can result in penalties.

On the other hand, if employers withhold taxes from non-taxable reimbursements, they’ll reduce the employee’s net salary and pay more in tax than needed.

Track and Record Out-of-Pocket Expenses With Paystub.org

Our pay stub generator allows you to quickly and effortlessly create detailed pay stubs to track and record out-of-pocket expenses, as well as other non-taxable and taxable payments.

Here’s a step-by-step process on how to create a pay stub in minutes:

1. Select a pay stub generator on our website (note that we also offer a Form W-2 generator, a Form 1099 generator, and an invoice generator).

2. Pick a template that aligns with your business needs.

3. Fill in the form with payment, company, and employee information.

4. Complete the earnings statement and use our built-in calculator for gross and net wages, as well as taxes.

5. Review your pay stub.

6. Check out to download a finished document.

Final Thoughts

Effectively managing out-of-pocket expenses allows companies to continue their operations smoothly without incurring additional taxes. However, this requires the expenses to be reimbursed under accountable plans, which means they must be reported on time and accompanied by receipts and other documents that prove their business-related nature.

To keep your records clean and help employees file their taxes, don’t forget to use professional and accurate pay stubs for expense tracking. Paystub.org’s generators allow you to create them in minutes and reduce unnecessary administrative burden while you focus on growing your business.

Out-of-Pocket Expenses FAQ

#1. What is not considered an out-of-pocket expense?

Personal expenses not directly related to business operations are not considered out-of-pocket expenses. This encompasses everything from daily commute to and from an office to regular meals and entertainment that’s not for client purposes.

#2. Can out-of-pocket expenses be deducted if reimbursed?

Out-of-pocket expenses can’t be deducted by employees if fully reimbursed by employers under an accountable plan. Since the reimbursement is tax-free, a deduction would result in a double benefit for the employee, which is not allowed.

#3. Why is my reimbursement on my pay stub?

Your reimbursement is on your pay stub to provide a clear and accurate record of the entirety of your earnings. It represents a confirmation that the employer paid you back for the business-related costs that you’ve incurred. This helps both parties track their finances and prepare for the tax season.