Decoding the 1099: Expense Reimbursements – Are They Included?

The short, definitive answer is: generally, no, expense reimbursements are not included on a 1099-NEC or 1099-MISC, provided certain conditions are met. However, like navigating any aspect of tax law, the devil is in the details. Let’s delve into the nuances of how expense reimbursements are treated concerning 1099 forms, ensuring you’re on solid footing when tax season rolls around.

Understanding the 1099 Landscape

Before we dive into the specifics of expense reimbursements, it’s crucial to grasp the fundamentals of the 1099 forms themselves. The 1099-NEC (Nonemployee Compensation) is primarily used to report payments made to independent contractors for services rendered. Think of your freelance web developer, your graphic designer, or that skilled consultant you hired for a specific project. The 1099-MISC (Miscellaneous Income), while less frequently used since the resurgence of the 1099-NEC, still reports various types of income, including rents, royalties, and certain other payments.

The key point? These forms report income. They report payments for services or other forms of compensation. This is the lens through which we need to view expense reimbursements.

The Crucial Distinction: Reimbursements vs. Compensation

The IRS draws a clear line between payments that are considered compensation and those that are legitimate reimbursements. A reimbursement is designed to make the contractor whole for expenses they incurred while performing services for you. It’s not intended to provide a profit or additional income. In essence, it’s about restoring the contractor’s financial position to what it was before they incurred the expense.

If the reimbursement genuinely reflects expenses directly related to the service performed, and the contractor has adequately accounted to the payer for these expenses, then the reimbursements generally do not need to be reported on a 1099. This “accounted to” part is absolutely vital. We’ll explore what it entails shortly.

The “Accounted To” Requirement: What Does It Mean?

“Accounted to” is IRS jargon that means the independent contractor provided you with sufficient documentation of their expenses. This documentation should include items such as:

• Receipts: Original receipts are gold. They provide concrete proof of the expense, the amount, and the date.
• Expense Reports: A structured report detailing the expenses incurred, the dates, the purpose, and the amount. This helps you easily verify the legitimacy of the expenses.
• Mileage Logs: If mileage is being reimbursed, a detailed log showing dates, destinations, and mileage is crucial. The reimbursement rate should align with the IRS standard mileage rate (though you can choose to reimburse at a lower rate).

The documentation needs to be timely. Ideally, the contractor should submit their expense report and supporting documents shortly after incurring the expenses. This ensures that the information is fresh and accurate.

Without adequate documentation, the IRS might view the reimbursement as disguised compensation, especially if the amount is excessive or unsubstantiated. And that’s when it gets reported on a 1099.

Scenarios Where Reimbursements Are Included on a 1099

Despite the general rule, there are scenarios where reimbursements must be reported on a 1099:

• Lack of Adequate Accounting: As previously emphasized, if the contractor doesn’t provide sufficient documentation of their expenses, the reimbursement becomes taxable income and must be reported.
• Reimbursements Exceed Actual Expenses: If you reimburse the contractor for more than the actual expenses they incurred, the excess amount is considered income and is reportable.
• Non-Business Related Expenses: If you reimburse for expenses that are not directly related to the services performed, those reimbursements are considered income. Think of a reimbursement for personal expenses, for example.
• Reimbursements Under an “Accountable Plan” That Fails IRS Requirements: Certain businesses set up expense reimbursement plans (accountable plans). If the plan fails to meet IRS specifications (e.g. timely submission of receipts), the reimbursement is considered income to the independent contractor.
• Payments Coded Incorrectly: Incorrectly coding payments can lead to the appearance of reimbursements being considered as income when it is not.

Best Practices for Handling Expense Reimbursements with Independent Contractors

To ensure compliance and avoid potential headaches, follow these best practices:

• Establish a Clear Policy: Develop a written policy outlining your expense reimbursement procedures for independent contractors. This policy should clearly state what types of expenses are reimbursable, the documentation required, and the deadlines for submission.
• Require Detailed Documentation: Insist on detailed documentation for all expense reimbursements. No receipts, no reimbursement (unless for small expenses where receipts are not typically provided, such as some toll costs).
• Timely Review and Verification: Review expense reports and supporting documentation promptly. Verify that the expenses are legitimate, reasonable, and directly related to the services performed.
• Accurate Record Keeping: Maintain accurate records of all expense reimbursements, including copies of expense reports, receipts, and payment details.
• Consult with a Tax Professional: If you have any doubts or complex scenarios, consult with a qualified tax professional. They can provide guidance tailored to your specific situation.

Frequently Asked Questions (FAQs)

Here are some frequently asked questions about expense reimbursements and 1099 forms:

1. What is the difference between an accountable and a non-accountable expense reimbursement plan?

An accountable plan meets specific IRS requirements, including having a business connection, requiring employees/contractors to substantiate expenses, and requiring them to return any excess reimbursement. If these conditions aren’t met, it’s a non-accountable plan, and reimbursements are treated as taxable income.

2. What types of expenses are commonly reimbursed to independent contractors?

Commonly reimbursed expenses include travel (mileage, airfare, lodging), meals, supplies, software subscriptions, and professional development directly related to the contracted work.

3. If I reimburse a contractor for mileage, what rate should I use?

You can reimburse at the IRS standard mileage rate (which changes annually) or at a lower rate. Reimbursing at a rate higher than the IRS rate may result in the excess being considered taxable income.

4. Are per diem payments considered expense reimbursements?

Per diem payments (a fixed amount per day for expenses) can be treated as reimbursements if they are based on reasonable federal per diem rates and the contractor substantiates the time, place, and business purpose of the travel. If not, they might be considered taxable income.

5. What happens if I accidentally include reimbursements on a 1099?

If you mistakenly include reimbursements on a 1099 that should not be included, you’ll need to file a corrected 1099. This involves filing a new 1099 with the correct information and sending it to the contractor and the IRS.

6. Do I need to report reimbursements for materials purchased by the contractor?

Generally, yes. If the contractor purchased materials and you reimburse them, those payments are typically reported as income on a 1099 if they meet the reporting threshold ($600 for 1099-NEC). However, if the materials are considered incidental to the service and are not separately stated or billed, they might be included as part of the overall service fee, which is then reported.

7. What if the independent contractor is an LLC or S-Corp? Does that change how reimbursements are treated?

The legal structure of the independent contractor (LLC, S-Corp, etc.) does not fundamentally change the rules regarding expense reimbursements and 1099 reporting. The key factor remains whether the reimbursements meet the criteria of being legitimate, substantiated expenses.

8. How long should I keep records of expense reimbursements?

The IRS generally recommends keeping tax records for at least three years from the date you filed your return or two years from the date you paid the tax, whichever is later. However, it’s always a good idea to consult with a tax professional to determine the appropriate record retention policy for your business.

9. What are the penalties for not filing 1099s correctly?

The penalties for failing to file 1099s correctly can be significant and vary depending on the severity of the infraction. They can range from $50 to $290 per form, depending on how late the form is filed and whether the failure was intentional. For intentional disregard, the penalty can be much higher.

10. Are there any exceptions to the $600 reporting threshold for 1099-NEC?

Yes, there are some exceptions. For example, if you withhold federal income tax from a contractor’s payment, you must file a 1099-NEC regardless of the amount. State reporting requirements might also have different thresholds.

11. Can I pay for expenses directly instead of reimbursing the contractor?

Yes. Paying for expenses directly (e.g., booking a hotel for the contractor, purchasing software for their use) avoids the need for reimbursement. These direct payments generally do not need to be reported on a 1099 as they are not considered payments to the contractor.

12. Is sales tax that is reimbursed to a contractor included on a 1099?

Generally, sales tax that is reimbursed is not included on a 1099. It’s treated as a pass-through expense, provided it’s separately stated and documented.

Navigating the complexities of 1099s and expense reimbursements requires attention to detail and a thorough understanding of IRS regulations. By following these guidelines and seeking professional advice when needed, you can ensure compliance and avoid potential tax problems. Keeping a clear paper trail and having open communication with your independent contractors are your best defenses against IRS scrutiny.