Moving Expenses - How to Correctly Treat Reimbursements

During the year many employers entice potential employees by offering the incentive of paying for their moving expenses, and many employers have also paid moving expenses for employees who relocate to a different branch office. These expenses may be taxable income to the employee or not, depending on the circumstances and the actual expenses paid.

Unlike most business expenses, moving expenses are not an ordinary or necessary business expense, so they may not be deductible on a business tax return. The general rule is that if an expense is not a deductible business expense, any reimbursement paid to an employee for such an expense must be treated as taxable compensation, subject to all income tax withholding. However, in this case the reimbursements may not be subject to tax withholding if the expense can be deducted on the employee's personal income tax return.

Individuals who move to another location for work may be able to deduct qualified moving expenses by completing Form 3903, Moving Expenses, and attaching the form to Form 1040.

How Can an Individual Qualify for the Moving Expense Deduction?

The answer to this question can be found in IRS Publication 521, Moving Expenses. For an individual's moving expenses to be qualified moving expenses, the individual must meet three tests:

The move is closely related to the individual's start of work.
The location of the individual's new home must meet the distance test.
The individual's employment must actually or potentially meet the time test.

The move is closely related to the individual's start of work if it occurs within 1 year of when the individual starts work at the new location. The individual does not have to have a new job at the time of the move, but he must start work within 1 year after moving for the expenses to be qualified expenses.

The distance test is based on the location of the individual's former home, the location of his old place of work, and the location of his new place of work. It has nothing to do with the location of his new residence. The individual's new place of work must be at least 50 miles further from his old residence than his old place of work was from his old residence. For instance, suppose that the employee used to travel 15 miles from his old home to his old place of work. His new place of work must be located at least 65 miles (15 + 50) from his old residence.

To meet the time test the individual must work full-time (as defined by the employer) at least 39 weeks during the first 12 months after arriving in the general location of his new job. The 39 weeks does not all have to be with the same company and they do not all have to be consecutive weeks. In addition, if the individual moves later in the year, the individual may still claim the deduction in the year he moves if he starts work at the new location in that year and expects to remain employed during the necessary weeks in the following year.

What Expenses Are Qualified Moving Expenses?

Generally speaking, the following expenses are defined as qualified expenses:

Moving the individual's household goods and personal effects (including in-transit storage expenses), and
Travel for a single trip for the individual and his family (including lodging during the travel and one night after arriving, but not meals) from the individual's old home to his new home. If the individual uses his own personal vehicle he may calculate the cost using the standard rate for moving expenses (which is 23.5 cents per mile in 2014).

Moving expenses, according to the Internal Revenue Code, must be reasonable, but the word reasonable is not defined. However, Publication 521 provides an extensive list of moving expenses that the IRS considers to be reasonable and deductible.

How Should Employers Treat Moving Expense Reimbursements to Employees?

All payments made to, or on behalf of, employees for moving expenses are deductible business expenses either as compensation to the employee or as qualified moving expenses. If the employer calculates what moving expenses incurred by an employee are qualified moving expenses, then those expenses are deductible as moving expenses. All payments that are not for qualified moving expenses must be treated as compensation subject to income tax withholding.

Qualified moving expenses that are reimbursed to the employee must be reported on the employee's Form W-2 in Box 12 with Code P. Qualified moving expenses that are paid directly to a third party, such as a moving company, are deductible and do not have to be reported on Form W-2. The total of all qualified payments, including third-party payments, must be included in the totals on both Lines 3 and 4 of Form 940, and Box 4e, “Other”, should be checked.

Consider an example. Company LMN pays a moving company $5,200 to move John Doe's household goods to a new location, and John submits the following expenses to Company LMN for reimbursement:

Mileage for 1 house-hunting trip and the actual move (350 miles in each direction). (350 mi x 3 x 0.235/mi = $246.75)
Hotel for house-hunting trip and 1 night after move. ($168 + $187 = $355)
Meal costs. ($178)
Total reimbursement to employee. ($246.75 + $355.00 + $178.00 = $779.75)

The house-hunting trip costs and all meals are not qualified moving expenses, so the employer has to calculate those expenses that do qualify.

Mileage for actual move. (350 mi x 0.235/mi = $82.25)
Hotel for one night of move. ($187.00)
Total qualified moving expenses. ($82.25 + $187.00 = $269.25)
Total non-qualified moving expenses. ($779.75 - $269.25 = $510.50)

The employer will have to calculate the tax withholding as follows and deduct it either from the reimbursement or one of the employee's paychecks:

Federal income tax deducted as supplemental wages. ($510.50 x 25% = $127.63)
Social security tax. ($510.50 x 6.2% = $31.66)
Medicare tax. ($510.50 x 1.45% = $7.41)

The fringe benefit must be reported as follows:

Include $510.50 in Boxes 1, 3 and 5 of Form W-2.
Include $127.63 in Box 2 of Form W-2.
Include $31.66 in Box 4 of Form W-2.
Include $7.41 in Box 6 of Form W-2.
Report $269.25 in Box 12 of Form W-2 with Code P. (Note: Qualified moving expenses paid directly to a third party should not be reported on Form W-2.)
Include total qualified expenses of $5,469.25 ($5,200.00 + $269.25) on Lines 3 and 4 of Form 940.

Reimbursing moving expenses is certainly an incentive that employers can use to recruit or assist employees. At times the issue, however, can be confusing. The above discussion should help employers handle matters properly and avoid any adverse tax consequences.