When payments are made under an accountable plan, they’re free from federal income and employment taxes for recipient employees. The employer benefits because the reimbursements aren’t subject to the employer’s portion of federal employment taxes.
When an employer pays an expense reimbursement or advances to an employee (regardless of whether the employee incurs or is reasonably expected to incur the expense), the IRS considers the arrangement to be disguised taxable compensation. Which means the purported expense reimbursement is treated as additional taxable compensation.
Accountable Plans 101
What are the accountable plan requirements?
Accountable plans must meet four requirements for payments to recipient employees to qualify as tax-favored expense reimbursements, rather than taxable compensation:
- Business connection. Reimbursements or allowances can be paid only for expenses incurred by employees regarding performing services for the employer. A common example is business-related travel expenses.
- Substantiation. Expenses must be substantiated by an expense report or similar record. Receipts should be required for expenses over $75. For lodging expenses, receipts are required regardless of the amount. An accountable plan can pay predetermined mileage or per-diem travel allowances up to the amounts paid to federal employees. Companies that opt for this simplified method don’t need their employees to substantiate actual expense amounts.
- Return of excess payments. Within a reasonable period, employees must be required to return reimbursements or advances that exceed actual substantiated expenses. Under an exception, employees aren’t required to return excess mileage or per-diem travel allowances based on the amounts allowed to federal employees.
- Reasonable time. Substantiation of expenses and the return of excess payments must occur within a reasonable period.
What are the expense reimbursement alternatives?
Unless your company’s expense reimbursement or allowance arrangement qualifies as an accountable plan, the IRS will treat payments as additional taxable compensation. Examples of arrangements that won’t qualify as include:
- designating part of an employee’s salary as a travel allowance, and
- reimbursing expenses out of the employee’s salary by reducing his or her paychecks by the reimbursed amounts.
For example, suppose ABC Technology Company operates expense reimbursement plans for its technicians and salespersons. On any day, a technician travels away from home on business, ABC designates $50 of that day’s pay as an allowance for travel expenses. The technician receives the $50, but his or her salary is reduced by that amount. The technicians aren’t required to substantiate actual travel expenses.
ABC also designates $500 of each salesperson’s monthly salary as an allowance for monthly business-related entertainment expenses. The salesperson receives the $500, but his or her monthly salary is reduced by that amount. Salespeople aren’t required to substantiate actual entertainment expenses.
These arrangements do not qualify as accountable plans because the allowances are paid regardless of whether the recipient employees incur business-related expenses and because the allowances are just part of the employees’ salaries. Therefore, ABC must report the allowances as taxable wages on the recipient employee’s W-2 forms.
The allowances are subject to federal income and employment taxes. ABC must withhold for federal income tax and the employee’s portion of federal employment taxes on the allowances. ABC also must pay the employer portion of federal employment taxes on the allowances.
How do I set up an accountable plan?
Consult your tax advisor for more details on how to set up an accountable plan.
Setting up an accountable plan for employees’ business-related expenses can save taxes for both the employees and the employer. LBMC would love to help you take advantage of this tax savings.
LBMC tax tips are provided as an informational and educational service for clients and friends of the firm. The communication is high-level and should not be considered as legal or tax advice to take any specific action. Individuals should consult with their personal tax or legal advisors before making any tax or legal-related decisions. In addition, the information and data presented are based on sources believed to be reliable, but we do not guarantee their accuracy or completeness. The information is current as of the date indicated and is subject to change without notice.