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Why You Need an “Accountable Plan” if You Reimburse Employee Expenses

July 23, 2015

The IRS is cracking down on reimbursements, make sure yours are for legitimate business expenses.

It’s common for employers to reimburse employees for business-related expenses such as travel. But for the reimbursement to be excluded from the employee’s taxable compensation yet still be deductible by the employer (subject to a 50% limit for most meal and entertainment expenses), it must be made in compliance with the rules for an “accountable plan.”

Exclusion from income saves not just income tax for the employee but also payroll taxes for both the employee and the employer. That’s why the IRS wants to make sure reimbursements are for legitimate business expenses, not a form of disguised compensation.

What’s Required

Under an accountable plan, employees must substantiate all reimbursed expenses. In addition, if they receive an advance, they must return any amount exceeding actual expenses incurred.
Both the substantiation and the return of excess advances must occur within a specified time period. For substantiation, this is usually within 60 days after the expenses were paid. For excess advances, it’s usually within 120 days after the expenses were paid.

Employee substantiation should note the amount, date, place, and business purpose of each expense. Substantiation for lodging and other travel expenses over $75 should include a receipt, canceled check or comparable record.

Qualifying Expenses
So what travel-related expenses are typically reimbursable under an accountable plan?

  • Transportation — airfare, taxis, public transportation, rental cars, mileage (if the employee is driving his or her own vehicle), parking, etc.,
  • Lodging
  • Meals
  • Business phone calls, Internet/WiFi for business purposes, etc., and
  • Tips

However, “lavish or extravagant” travel expenses can’t be excluded or deducted unless reasonable under the circumstances.

Don’t forget that, in most cases, only 50% of business-related meal or entertainment expenses are deductible by the employer, though the entire amount is excluded from the employee’s taxable income.

Unaccountable Plans

So what happens if you reimburse employees without having an accountable plan, or if employees don’t comply with your plan? The good news for you as the employer is that the reimbursements (and advances) are still deductible. But they’ll be considered taxable compensation to the employee. So they’ll be subject to income tax withholding and payroll taxes — both the employee and employer portions — and must be included on the employee’s W-2 form for the year.

Employees may be able to deduct on their personal tax returns the business expenses they incurred. But they’ll enjoy tax savings only if their total miscellaneous itemized deductions for the year exceed 2% of their adjusted gross income.

Is Your Plan Accountable?

Whether you’d like to set up an accountable plan or you’d like to find out if your reimbursement policy qualifies as one, we can help. Please contact us for more information.

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