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Both employees and independent contractors can deduct business expenses on their tax returns to lower their taxable income. But if you're reimbursed for your business expenses, you can no longer claim the expenses as deductions. Reimbursements are not counted as taxable income unless you cannot prove, in the case of an audit, either the reimbursement or the expense for which you were reimbursed.
When you're reimbursed for a business expense, you don't need to claim the reimbursement on your 1040. Your employer or client is, however, permitted to claim the deduction as a business expense on her tax return. You must retain records of both the expense and the reimbursement. The IRS can audit you for up to three years after your tax return is filed, but has as long as six years if there is a significant error, so retain your records for at least seven years.
Reimbursement Income Exceptions
If you can't prove the expense, the reimbursement does count as income. It's not enough to simply estimate an expense. You must have actual proof of the expense in the form of bills, credit card statements, receipts or -- in the case of mileage and similar travel expenses -- an expense log. If you are audited and can't prove the expense, the IRS will add the reimbursement to your taxable income and you may have to pay back taxes, interest and late penalties.
Some companies pay employees from an expense account or allot a set amount of money for each day of travel expenses. If you exceed this amount but your expenses are still tax-deductible, you can claim the amount in excess of the reimbursement as a deduction. For example, if you are paid $50 per day for travel expenses, but your travel expenses were $100, you can claim $50 in deductions. If you find yourself in the opposite situation -- where the amount of reimbursement exceeds your expenses -- you will need to claim this money on your W-2.
Tax Filing Information
You don't need to itemize reimbursed expenses or the payment for them on your tax return. However, if you claim a deduction for which you are only partially reimbursed, you'll generally need to itemize it. Some expenses can be itemized on your 1040, but others require special forms. Most business expenses are itemized on Schedule A.
The fact that you've been reimbursed for something doesn't necessarily mean it's a deductible expense. If your expense isn't deductible, you must claim the reimbursement as income. For example, if you are reimbursed for driving to and from work, this is non-deductible and therefore must be reported on your W-2. You must also give adequate reporting to your employer of your business expenses, and be prepared to show the IRS proof of your expenses if you are ever audited; otherwise, the reimbursement might be considered income.
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