The Cabinet minister boarded the train to Euston at Wilmslow, Cheshire this afternoon, before settling into first class with his special adviser.
But he was then challenged by a ticket collector who refused to allow the Chancellor to remain in his premium-priced seat - unless he paid the extra.
His special adviser reportedly said Mr Osborne, number three politician in the Cabinet, could not possibly remove himself to sit among the general public in standard class for the two hour journey to London.
The embarrassing gaffe, described as a "stand-off", was observed by ITV reporter Rachel Townsend who tweeted the exchange between the Tory MP and the ticket collector.
The journalist tweeted: "Very interesting train journey to Euston Chancellor George Osborne just got on at Wilmslow with a STANDARD ticket and he has sat in FIRST CLASS."
She told ITV: "George Osborne got on the train with aides at Wilmslow and went straight to first class.
"Then his aide approached the ticket collector right next to me. He said he is travelling with George and he has a standard ticket but can he remain in first class?
"The guard said no. The aide said Osborne couldn't possibly sit in standard class. The guard replied saying if he wants to stay it's £160.
"The aide said he couldn't pay and he couldn't really sit in standard. The guard refused to budge.
"The guard went on gathering tickets and later told me Osborne had agreed to cough up the £160."
Shadow Cabinet Office minister Michael Dugher said: "Another day, another demonstration of how out of touch this Government is.
"Just like Andrew Mitchell, George Osborne obviously thinks it's one rule for him and another for the plebs he's so keen to sit apart from. So much for 'we're all in it together'."
Bob Crow, leader of the RMT rail union, said: "This says it all about this rotten Government. Here we have a millionaire Chancellor who thinks he's above the normal rules and laws. George Osborne attempting to bunk first class is this ConDem administration in a nutshell."
A standard off-peak return ticket from Wilmslow to Euston normally costs £72.50, though it is not known what type of standard class fare the Chancellor had bought.
The incident happened on a Virgin Trains service on the West Coast Mainline - the route franchise controversially awarded to FirstGroup before the decision was scrapped over "technical flaws" in the bid process.