Are Employee Relocation Expenses Taxable?

Employee relocation is an essential part of many businesses. When employees are required to relocate for work, they may have to pay for moving charges, interim housing, and travel expenditures. Employers frequently cover these costs, either upfront or through employee reimbursement. However, the question arises, are these relocation expenses taxable? This article will explore the tax implications of employee relocation expenses.

What Are Employee Relocation Expenses?

The fees incurred by an employee when they migrate for work-related reasons are referred to as employee relocation expenses. These expenses include moving, temporary housing, travel, and other related costs. The company may directly pay for some or all of these costs or reimburse the employee for any out-of-pocket costs.

How Are Employee Relocation Expenses Taxed?

Employee relocation costs may be taxed depending on several variables, including their nature, the employer’s reimbursement program, and the employee’s tax situation. The Internal Revenue Service (IRS) typically views employee relocation costs as taxable income unless they qualify for one of a few exceptions.

Taxable Employee Relocation Expenses

Most employee relocation costs are regarded as taxable income and are therefore subject to Social Security and Medicare taxes, as well as federal, state, and municipal income taxes. Some of the everyday taxable employee relocation expenses include:

  • Relocation Bonuses: A relocation bonus is a lump sum paid by the employer to the employee to cover the relocation costs. This bonus is taxable income to the employee.
  • Temporary Living Expenses: When employees relocate, they may need temporary housing until they find a permanent residence. The employer may cover the cost of temporary housing, but these expenses are considered taxable income to the employee.
  • Home Sale Or Purchase Costs: When an employee is required to sell their home or purchase a new home due to relocation, the costs associated with these transactions, such as real estate commissions, closing costs, and mortgage fees, are taxable to the employee.
  • Moving Expenses: When employees relocate, the employer may cover moving their belongings. However, these expenses are considered taxable income to the employee unless they fall under certain exceptions, such as the distance test.
  • Travel Expenses: When an employee travels for work-related purposes, such as to find a new residence or to attend training, the expenses incurred are considered taxable income to the employee.

Nontaxable employee relocation expenses

Although most employee relocation expenses are taxable, some may be considered nontaxable under certain circumstances. Some of the everyday nontaxable employee relocation expenses include:

  • Qualified Moving Expenses: If an employee moves for work-related purposes and meets the distance and time tests, the expenses incurred may be non-taxable. The distance test requires the new workplace to be 50 miles farther from the employee’s former home than their old workplace. The time test requires the employee to work full-time for at least 39 weeks during the first 12 months after the move.
  • Per Diem Payments: When an employee incurs lodging, meals, and incidental expenses while away from home for work-related purposes, the employer may provide per diem payments. These payments are only applicable within the federal per diem rates.
  • Household Goods and Personal Effects: Moving household goods and personal effects, such as furniture and clothing, are nontaxable if the expenses are reasonable and necessary.
  • Temporary Living Expenses: If an employee relocates for a temporary assignment and intends to return to their former residence, the cost of temporary housing may be non-taxable.

How Are Employee Relocation Expenses Reimbursed?

Employers may reimburse employees for relocation expenses in various ways. Some employers may cover the expenses directly, while others may reimburse the employee after the expenses have been incurred. How the reimbursement is provided can impact the tax treatment of the expenses.

  • Direct Payment by The Employer: If the employer covers the expenses directly, the expenses are considered taxable income to the employee. The employer must include the value of the expenses in the employee’s wages and report them on their W-2 form.
  • Reimbursement By the Employer: If the employer reimburses the employee for the expenses incurred, the tax treatment depends on whether the reimbursement is made under an accountable or non-accountable plan.

Under an accountable plan, the reimbursement is not considered taxable income to the employee, and the employer can deduct the expenses as a business expense. To qualify as an accountable plan, the reimbursement must meet the following requirements:

  • The expenses must be business-related and incurred while the employee performs services for the employer.
  • The employee must provide the employer with adequate documentation of the expenses, such as receipts or invoices.
  • Any excess reimbursement or advance payment must be returned to the employer within a reasonable period.

Under a non-accountable plan, the reimbursement is considered taxable income to the employee, and the employer cannot deduct the expenses as a business expense. To avoid this treatment, the employer must ensure the reimbursement is made under an accountable plan.

Reporting Employee Relocation Expenses on Tax Returns

Employees who incur taxable relocation expenses must report them on their tax return. These expenses are reported on Form 3903, Moving Expenses, and are deducted as an adjustment to income on Form 1040.

If the employee is reimbursed for the expenses under an accountable plan, they do not need to report the reimbursement as income on their tax return. If the reimbursement is made under a non-accountable plan, it is reported as income on Form W-2 and is subject to income and payroll taxes.

Exceptions and Special Rules for Certain Types of Employee Relocation Expenses

Some exceptions and special rules exist for certain types of employee relocation expenses. For example:

  • Military Personnel: Members of the military who are required to move due to a permanent change of station may be eligible for nontaxable moving expenses.
  • Foreign Assignments: Employees sent on foreign assignments may be eligible for special tax treatment for moving expenses.
  • Self-Employed Individuals: Individuals who relocate for work-related purposes may be eligible to deduct their moving expenses on their tax returns.

Employee relocation expenses can be complicated from a tax perspective. Most relocation expenses are taxable income to the employee unless they fall under certain exceptions. Employers must ensure that they follow the proper reimbursement policies and account for the tax implications of relocation expenses. Employees must also be aware of the tax treatment of their relocation expenses and report them properly on their tax returns. Consulting with a tax professional can help employers and employees navigate the complex tax rules associated with employee relocation expenses.