Disbursement vs. Reimbursement: Key Differences Explained

Disbursements represent direct payments from a company's bank account to third parties like vendors or contractors, while reimbursements compensate individuals who paid business expenses out-of-pocket. Getting this wrong creates tax problems, particularly around IRS accountable plan rules that determine whether reimbursements stay non-taxable or convert to taxable compensation. This guide covers what separates these payment types, how the IRS accountable plan test works, and the documentation requirements companies need to avoid penalties.

Disbursement vs. reimbursement at a glance

What is a disbursement?

A disbursement is payment from a company's bank account directly to a vendor, contractor, or other third party. The company owns the expense from the start and never expects the money back. Common types include operating disbursements (vendor payments, contractor fees, payroll), loan disbursements (funds from lenders), dividend disbursements (profit distributions), and controlled disbursements (same-day payment notifications).

Companies typically see invoice processing costs drop from $15.96 to $2.94 per invoice through automation. A software company hiring a contractor to redesign its website receives a $15,000 invoice, verifies it matches contract terms, then schedules ACH payment. The company owns this expense from inception because the contractor was never out-of-pocket.

What is a reimbursement?

Reimbursements pay people back for business expenses they covered with personal funds. When an employee books a hotel for a business trip or a consultant purchases supplies to complete a project, they're fronting money that belongs to the business. Reimbursement restores those funds and properly categorizes the expense in the accounting system, provided the arrangement meets three IRS requirements under Treasury Regulation § 1.62-2.

According to AICPA-CIMA guidance, reimbursements must meet all three accountable plan requirements to remain non-taxable: business connection (ordinary and necessary business expenses), substantiation within the IRS safe harbor of 60 days, and return of excess amounts within the IRS safe harbor of 120 days.

Here's how this works in practice. A marketing consultant travels to a client site, books a $150 train ticket and purchases a $45 client lunch using her personal card. She submits expense reports within 10 days with receipts, the meeting agenda, and business purpose attestation. The company records $195 in Employee Reimbursements Payable and processes payment. Because this meets all three IRS requirements, the $195 remains non-taxable to the employee.

The agent vs. principal rule: how to tell them apart

The agent rule is when a company acts as an agent facilitating a transaction on someone else's behalf (typically a client), the expense belongs to the principal rather than to the company. A law firm paying court filing fees directly to the court on behalf of a client acts as an agent. The firm records this as a pass-through transaction, typically showing it separately on the client invoice from legal fees.

The principal rule is when a company incurs expenses in its own name to deliver a service or product, the company is the principal and these are generally deductible business expenses. The company owns the expense and claims the deduction.

The key difference between these two is ownership. Agent transactions pass through to the client who ultimately owns the expense. Principal transactions belong to the company that incurred them. For employee reimbursements, companies must ensure the arrangement meets all three IRS accountable plan requirements to keep reimbursements non-taxable: business connection, substantiation within 60 days, and return of excess within 120 days.

Why proper classification matters

Getting this distinction right delivers benefits across the entire finance operation:

• Better cash flow control: Companies can forecast vendor disbursements and employee reimbursements on different cycles, improving the ability to manage working capital and plan for payment timing based on distinct schedules.
• Tax optimization: Ensuring reimbursements meet accountable plan requirements keeps them non-taxable rather than converting to taxable compensation, avoiding both employee tax burden and employer payroll tax obligations.
• Audit protection: Proper documentation clearly distinguishes between company-owned expenses (disbursements) and employee-fronted expenses (reimbursements), creating a defensible paper trail that holds up during IRS reviews.
• Automation opportunities: Modern expense management platforms can route disbursements and reimbursements through different workflows based on classification rules, reducing manual processing time and error rates.

These benefits compound as teams grow and transaction volume increases. What starts as a minor administrative difference at 10 employees becomes significant at 100 employees when the volume of both payment types increases substantially.

Tax implications and compliance requirements

The tax treatment differs substantially between disbursements and reimbursements. Getting this wrong triggers penalties ranging from $60 to $310 per incorrect form depending on how late the filing occurs, plus potential 100% trust fund recovery penalties for responsible persons.

Disbursements to vendors and contractors require proper 1099 reporting when applicable. For reimbursements, the stakes are higher because misclassification affects both the company and the employee. When a reimbursement process meets the three accountable plan requirements, the payments aren't included in employee gross income, aren't subject to federal income tax withholding, aren't reported on Form W-2, and aren't subject to FICA or FUTA taxes. When the process fails any of these tests, every reimbursement converts to taxable compensation with all associated payroll tax obligations.

The penalty structure is steep. Late W-2 filings trigger penalties starting at $60 per form if corrected within 30 days, increasing to $120 if corrected between 30 days and August 1, and reaching $310 per form for filings after August 1. For a company with 100 employees, misclassified reimbursements could result in significant employer FICA tax liability and substantial W-2 penalties.

Best practices: how to manage disbursements and reimbursements

Proper documentation and automation are your best defense against compliance issues and penalties. This becomes especially critical once you're processing regular employee reimbursements, typically around 20 or more employees, when the penalty exposure outweighs manual tracking. Set up distinct liability accounts for accounts payable (vendor disbursements) and employee reimbursements payable so you can forecast cash requirements and identify processing delays more easily.

Document everything

Proper documentation protects you during audits and maintains tax compliance. For expenses of $75 or more, keep the payee, amount paid, proof of payment, date incurred, and description of the item or service. For reimbursements under an accountable plan:

• Include explanation of business purpose.
• Substantiate within 60 days.
• Return excess amounts within 120 days.
• Store records for at least three years.

Your expense management system should automatically flag late submissions and unreturned advances based on these IRS safe harbor periods. Written accountable plan policies should state these timing requirements explicitly and make them part of onboarding for new employees.

Automate your expense management

Modern automation tools significantly improve expense processing efficiency while reducing manual burden. Manual invoice processing costs average $15.96 per invoice compared to $2.94 with automation, according to industry benchmarks. For a company processing 500 invoices monthly, that's annual savings of $78,120.

Modern expense management platforms handle key tasks automatically:

• Extract data from receipts using OCR and AI.
• Categorize expenses based on merchant and purchase patterns.
• Route approvals based on configured rules.
• Flag potential violations of accountable plan timing requirements.

The benefit extends beyond cost savings to include improved compliance through systematic enforcement of documentation requirements and timing rules that are easy to miss in manual processes.

Frequently asked questions

Is payroll a disbursement?

Yes. Payroll is a specific type of disbursement where companies pay funds from business accounts to employees as compensation. The withholding of federal income tax, FICA taxes, and other deductions creates additional liabilities that require timely payment to avoid penalties ranging from 2% to 10% of unpaid taxes.

Can I add markup when reimbursing myself for business expenses?

No. If you add markup when passing a cost through to a client, it stops being a reimbursement and becomes a sale. The entire amount (original cost plus markup) becomes revenue that you need to recognize properly on your books.

What happens if I accidentally reimburse an employee for something that should have been a direct vendor payment?

If the reimbursement doesn't meet the three strict IRS accountable plan requirements (business connection, substantiation within 60 days, and return of excess within 120 days), the IRS may view it as taxable compensation. This creates tax liability for the employee and payroll tax obligations for your company.

Are customer refunds considered disbursements or reimbursements?

Neither, really. Customer refunds get their own accounting treatment. You record them by debiting sales returns and allowances and crediting cash, which reduces your net revenue for the period.