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Accounting and Tax Planning

A Proactive Step That Adds Up

By Joe Lemay, CPA

I’m sure you’ve heard by now, but there were quite a few changes to the tax law in 2018. When the Tax Cuts and Jobs Act (TCJA) was signed into law into December 2017, it took an axe to many itemized deductions on your personal return.

Of these, the deduction for unreimbursed employee business expenses, such as business travel or car expenses, tolls, and parking, is one of significant note. However, despite the lost deduction, there may be an alternative solution that can be a win-win for employers and employees.

Prior to the TCJA, unreimbursed employee business expenses were deductible as a ‘miscellaneous’ deduction on an individual’s return. All miscellaneous deductions were deductible in excess of 2% of adjusted gross income (AGI).

For example, if your AGI was $100,000 in 2017, you could claim only a deduction for the amount of your total miscellaneous expenses that exceeded $2,000. If you had a total of $3,200 of unreimbursed employee expenses, you would have been able to deduct $1,200 on your personal return in 2017. Now fast-forward to 2018, and the $3,200 of unreimbursed employee expenses are not deductible at all on the individual return.

The Solution

You may be thinking the changes noted above sound unfair. However, a company can establish an ‘accountable plan,’ which may serve to remedy this change. An accountable plan is a reimbursement or other expense-allowance arrangement between an employer and employee, which reimburses employees for business expenses that are not recorded as income to the employee and are generally deductible by the employer as business expenses.

If the accountable plan is followed properly, the company reimburses an employee for substantiated business expenses, and then, in turn, the company deducts those business expenses on its income-tax return. The reimbursements are excluded from the employee’s gross income, not reported as wages or other compensation on the employee’s W-2, and are also exempt from federal income-tax withholding and employment taxes.

The company can negotiate with the employee to reduce the employee’s wages in exchange for the reimbursement, thereby saving the company payroll taxes, which includes Social Security tax of 6.2% on gross wages, capped at $132,900 (for 2018) and Medicare tax of 1.45%. By executing this transaction appropriately, the employee receives full reimbursement for business expenses, while seeing no change in their overall income, and the company benefits by saving on payroll taxes.

For example, Johnson Inc. has a sales team, which includes its ace salesman, Dave. During 2017, Dave earned $105,000 in base compensation and had $7,000 of unreimbursed business expenses. Assuming Dave’s base compensation of $105,000 is also his adjusted gross income, Dave would have been able to deduct $4,900 of his unreimbursed business expenses on his personal tax return in 2017. The remaining $2,100 of unreimbursed business expenses is a lost deduction.

Now let’s assume Johnson Inc. establishes and properly follows an accountable plan in 2018. During 2018, Dave earns the same $105,000 reduced by the elective expense allowance of $7,000 to a new taxable base of $98,000. Under the accountable plan, Dave is reimbursed in full for his business expenses; therefore, his net income, subsequent to reimbursements, remains the same as 2017 at $98,000. However, in this scenario, the company saves Social Security and Medicare tax in the amount of $535 (7.65% combined tax rate multiplied by $7,000 of reduced wages). While this savings may not seem like a lot, imagine a sales team of 25 employees; that is a potential savings of $13,375. Think about what you could do with that savings as a business owner.

How to Establish an Accountable Plan

The following criteria must be met for the plan to be accountable:

The accountable plan must prove the business connection for the reimbursements and/or allowances. The typical allowable deductions are travel, supplies, local transportation, meals incurred while away on business, and lodging.

The accountable plan must also have adequate support and records (such as itemized receipts) that substantiate the expense’s amount and purpose. The substantiation should be examined and approved by a manager or supervisor. The plan also requires the employee to return any advances back to the company which are not business expenses. Excess advances must be returned to the company within a reasonable period after the expense is paid or incurred. If excess advances to employees are pocketed by the employee, the excess advances are subject to federal income-tax withholdings and employment taxes.

The business-connection requirement is satisfied if a plan only reimburses employees when a deductible business expense has been incurred in connection with performing services for the company and the reimbursement is not in lieu of wages that the employees would otherwise receive. The company cannot simply shift taxable wages to the employee to non-taxable reimbursements without adequately proving the business connection.

There is no specific IRS form used to adopt an accountable plan, nor does the tax law require an accountable plan to be in writing; however, it would behoove employers to write down a formal plan.

Costs and Benefits of an Accountable Plan

The benefits produced from an effective accountable plan are clear. The employee is reimbursed in full for business expenses, and the company can save on payroll taxes, a win all around for everyone. However, the costs of implementing an accountable plan must also be factored in.

The company must have an organized process for tracking employee reimbursements, maintaining appropriate support that substantiates the business connection of employee reimbursements and is timely with reimbursements and requests for payback from its employees.

Companies with highly functioning accounting and/or human-resource departments will not have an issue with meeting these tasks; however, companies with low-functioning accounting and human-resource departments could struggle with appropriately maintaining an accountable plan.

Conclusion

Utilizing an accountable plan is an overall win for employers and employees. But consistency must be maintained throughout the year in order to yield the benefits.

Joe Lemay, CPA is a senior associate with the Holyoke-based public accounting firm Meyers Brothers Kalicka, P.C.; (413) 322-3520; [email protected]

Accounting and Tax Planning

Items That Add Up

By Kathryn A. Sisson, CPA, MST

There are many changes that businesses and individuals should be aware of under The Tax Cuts and Jobs Act (TCJA), the most significant tax legislation in the U.S. in more than 30 years. Here are the 10 changes that will have the most significant impact this tax season.

Individuals

1. Tax Rates. The 2018 tax brackets have changed, resulting in lower tax rates for most individuals. For example, the 15% tax bracket has been reduced to 12% and the 25% bracket to 22%.

2. Income-tax Withholding. As a result of the lower taxes rates, income-tax withholding during 2018 also decreased for most individuals. This could result in underpayment of taxes for 2018, depending on your tax situation. Taxpayers should carefully review their withholding going into 2019 and discuss it with their tax professional.

3. Itemized Deductions. TCJA made several changes to itemized deductions as noted below.

Medical Expenses: TCJA lowered the threshold for the medical-expense deduction to 7.5% of AGI for 2017 and 2018. The threshold for 2019 is 10% for most taxpayers.

State and Local Taxes: TCJA limits the deduction for state and local taxes to $10,000 per year. This includes payments for state income tax, property tax, and excise tax. The same $10,000 limit applies regardless of whether you are a single taxpayer or if you are married and file a joint return. The deduction for taxpayers who are married and filing separate returns is limited to $5,000.

Kathryn A. Sisson

Kathryn A. Sisson

Mortgage Interest: Interest is generally deductible on original home acquisition debt up to $750,000. Home-equity interest is deductible only if the funds were used to improve the mortgaged property.

Charitable Donations: Donations are generally deductible up to 60% of AGI, up from 50%, for most donations. You could also consider giving directly from your IRA if you are over age 70 1/2 or gifting appreciated stock directly to a charity. Discuss with your tax professional in order to maximize your benefit.

Miscellaneous Itemized Deductions: TCJA has eliminated miscellaneous itemized deductions. These include deductions for unreimbursed employee business expenses, tax-preparation fees, and investment-advisory fees.

4. Increased Standard Deduction. One of the most significant provisions of TCJA is the near-doubling of the standard deduction for all taxpayers. For 2018, the standard deduction amounts are $24,000 for joint filers, $18,000 for head of household, and $12,000 for all other filers. The limitations on itemized deductions as noted above and the increased standard deduction amounts may make it less advantageous to itemize deductions.

5. Personal Exemptions. TCJA eliminated personal exemptions for 2018. For 2017, taxpayers received a personal exemption deduction of $4,050 per person. Therefore, a family of four received a deduction of $16,200 in 2017 that is no longer available under the new tax act.

Businesses

6. Tax Rates. A flat tax rate of 21% replaces the graduated tax rate brackets for C corporations that ranged from 15% to 39% in prior years.

7. Qualified Business Income (QBI) Deduction. A deduction of up to 20% of business income may be available to owners of pass-through entities. There are limitations based on several factors, including income of the taxpayer as well as the type of trade or business. The purpose of the deduction is to provide some parity between the new flat 21% corporate rate and the tax rates paid by owners of pass-through entities on their individual income-tax returns.

8. Depreciation. TCJA made significant changes to encourage businesses to expand and invest in new property; 100% bonus depreciation is now available for federal purposes, and the limitation on expensing certain assets has been increased to $1 million, with a $2.5 million investment limitation.

9. Business Credits. TCJA created a Family Leave Credit for employers making family-leave payments to employees. The credit is available only to employers who have a written policy in place for the payment and credit.

10. Deductions. Previously, the deduction for meals and entertainment was limited to 50% of expenses incurred. For 2018, 50% of meals are still deductible; however, entertainment expenses are no longer deductible.

Many of these changes are significant and warrant your full attention. As you approach tax season this year, seek the assistance of tax professionals, and do not follow your neighbor’s tax advice.

Kathryn A. Sisson, CPA, MST is a tax manager in the Commercial Services Department of Melanson Heath in Greenfield. She has 20 years of experience in public accounting and has been with Melanson Heath for 10 years. She has extensive experience in corporate and individual income-tax planning and review as well as financial-statement compilations and reviews. Her corporate experience includes working with businesses doing business in multiple states. She is also a QuickBooks ProAdvisor assisting many clients with general ledger systems and software training.

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