A Numbers Game
How to Appropriately Account for Incurred Business Expenses
Jennifer Reynolds
Accountable Versus Non-accountable Plans
Please don’t stop reading; these are really just technical terms for something rather non-technical. When a business owner reimburses an employee for expenses incurred during the normal course of business, as an employee, how that owner reimburses the employee determines the tax implications to both the employer and employee.
Under an ‘accountable plan,’ if the employee substantiates his or her expenses incurred (i.e. provides receipts to the employer), the employer can reimburse the employee for those expenses. This reimbursement is not considered taxable income to the employee, nor will the employer be required to withhold federal, state, or FICA taxes on the reimbursed amount.
Alternatively, under a ‘non-accountable plan,’ if an employer reimburses an employee without requiring the employee to substantiate expenses (i.e. no receipts or other documents submitted to the employer to confirm the expense), the payment to the employee becomes taxable income to the employee and is further subject to payroll taxes to both the employer and employee, and is also subject to federal and state income tax withholding to the employee.
Criteria for an Accountable Plan
For a company plan to be accountable, your company’s employees must satisfy three requirements. They must have:
• Paid for or incurred deductible expenses while performing services as an employee of your company;
• Adequately accounted to the company for the aforementioned expenses within a reasonable period of time; and
• Returned any excess reimbursement or allowance within a reasonable period of time back to the employer.
To adequately account for the employee’s expenses under the second requirement, employees must provide the company with substantiation of his or her travel, mileage, or other employee business expenses. For example, the employee must supply receipts and a statement of expense, account book, or similar record where the employee entered each expense at or near the time it was incurred in order to meet the contemporaneous requirement. Special rules apply to ‘per-diem’ reimbursements and are discussed later.
For the third requirement, an excess reimbursement or allowance is any amount a company pays an employee in excess of the actual business-related expenses for which he or she has adequately accounted. For example, if your company’s plan advances money to employees, the third requirement will be met only if the advance is reasonably calculated not to exceed the amount of anticipated expenses and the company policy requires the employee return the excess advance within a reasonable period of time.
The IRS has recognized that a ‘reasonable period of time’ depends on facts and circumstances. The following time frames were deemed to have taken place within a ‘reasonable period of time’ for guidance:
• The company advances to an employee within 30 days of the date the employee incurs the expense;
• The employee adequately accounts for his or her expenses within 60 days after the expenses were paid or incurred; and
• The employee returns any excess reimbursement within 120 days after expenses were paid or incurred.
As an alternative, many companies have abandoned the practice of expense allowances and implemented a reimbursement policy, whereby employers reimburse the employees weekly or monthly for out-of-pocket expenses incurred on the company’s behalf rather than tracking advances against actual expenses and reconciling any differences. To receive reimbursement, the employees must submit expense reports with attached receipts and adequate documentation to support a contemporaneous reimbursement.
What if an employer maintains an accountable plan but the reimbursement excess isn’t returned? What happens if an employer maintains an accountable plan that requires the return of excess advances, but the excess isn’t returned by the employee? If an adequate accounting is made to comply with all criteria of an accountable plan except the excess isn’t returned by the employee, then the employer must report the excess amount as wages.
However, if the IRS concludes that an employer’s reimbursement or other expense-allowance arrangement evidences a pattern of abuse of the rules and regulations, all payments made under the arrangement will be treated as made under a non-accountable plan, and the entire payment to the employee (both substantiated and excess) will be included the employee’s gross income, and will be reported as wages and subject to withholding and employment taxes.
Travel and Mileage Rules
A reimbursement arrangement that pays employees a fixed ‘per-diem’ amount for hotel, meals, and incidentals or a mileage-based amount (for business use of the employee’s vehicle) requires neither substantiation of actual amounts spent or the return of reimbursement in excess of the employee’s actual expense.
The IRS has issued tables defining maximum allowed per-diem rates for employers to treat per-diem or mileage-reimbursement plans as accountable plans, provided the amount paid is equal to or less than the maximum allowable rate.
Even if the employer’s reimbursement rates do not exceed the IRS rates, the employee still needs to substantiate time, place, business purpose, and mileage amounts (for mileage reimbursements) in order to comply with an accountable plan and to be excluded the reimbursement from wages, employment, and withholding taxes.
The tax rules relating to accountable plans can be complex, so addressing them now will avoid year-end payroll problems. This article is intended to provide general information regarding accountable plans. As always, you should consult your tax or legal advisor before applying it to your specific business situation.
Jennifer Reynolds is a tax manager with the Holyoke-based certified public accounting firm Meyers Brothers Kalicka, P.C.; (413) 322-3542; jreynolds@mbkcpa
