ACCOUNTABLE PLANS: REIMBURSEMENTS OF LEGITIMATE BUSINESS EXPENSES: IRS PUBLICATION #535; REVENUE RULING 2012-25
(METHODS OF REIMBURSING EMPLOYEES FOR LEGITIMATE BUSINESS EXPENSES)
An accountable plan is a tax-favored plan which allows a business to reimburse both regular employees and owner/employees for legitimate business expenses these individuals incur and pay out-of-pocket to conduct business.
When the rules for an accountable plan are strictly followed, the business gets their normal tax deduction for the business expense(s) reimbursed and the employee or owner/employee receives the reimbursement tax-free.
Thus, under an accountable plan, employee reimbursements require careful compliance otherwise the reimbursements will be deemed paid under a nonaccountable plan and treated as taxable compensation to the employee and subject to employment taxes.
To offer an accountable plan, and employer MUST COMPLY with 3 standards:
1-The expenses must have a business connection;
2-The expenses must be documented and substantiated within a reasonable time period; and
3-The employee must return an money not spent to the employer within a reasonable time period.
Again, if any of the 3 standards isn't met, the reimbursement arrangement is treated as a nonaccountable plan-the reimbursements are taxable compensation to the employee and subject to employment taxes.
Business Connection:
Although not required (to be in writing) the employer should have a written plan in place that authorizes the purchase (expense) for a legitimate business purpose, for a real business purpose, with a real business connection (reimbursements must have a clear correlation to actual expenses). The plan should indicate which business expense or expenses are eligible for reimbursement. Reimbursement of an expense does not change the deductibility of the expense itself for the business (they deduct the expense as they normally would).
NOTE: An employer can have different arrangements with different employees (which should be in writing) and if one employee fails to comply with the plan requirements, only that employee will be affected.
Documentation & Substantiation Within a Reasonable Time Period:
This requires both the employer and the employee to fully document and substantiate each expense that generally shows the date, amount, location, and business porpose for the expense. Each expense must be fully documented and substantiated-electronic or written account book, calendars, daily/weekly logs, bills/receipts, bank or credit card statements and so on.
NOTE: Insufficient records, estimates, etc are not permitted.
Within a reasonable time period and to be on the safe side if the IRS audits the plan or expense, the plan should require the expense be documented substantiated to the payer within 60-days after it is paid or incurred (and the employer should retain all proper documentation).
Returning any reimbursement not spent
The employee must return any excess reimbursement or allowances (money not spent) to the employer within 60-days.
To avoid any potential problems, the employer could reimburse the expense after it has been paid or incurred and submitted to the employer for the actula amount (and not use advances, estimates, etc.).
Written Accoutable Plans
A written accountable plan provides a structure to ensure that the 3 required standards are addressed and met. A written reimbursement paln should clarify:
1-Employee's name and job description
2-Each expense that is reimburseable for that employee
3-Maximum allowable amount for each expense
4-Time period for the employee to submit documentation and substantion for each expense.
5-Process for requesting reimbursement, including what documents are required to prove the request.
6-Process for returning excess reimbursements or allowances
WARNING:
Business owners should not ignore the rules, requirements, or paperwork involed.
Business owners should also put in their formal business resolutions a signed and dated copy of the written accountable plan.
By strictly following the compliance rules, you can minimize or even avoid a potential IRS tax problem.
A Few Extra Notes:
Car expenses can be reimbursed at the standard mileage rate (and the employee still needs to keep proper auto use records to document the business use of the car)
Expenses related to an employee's spouse and family attendance at business events are not deductible and not reimburseable under an accountable plan, unless it can be clearly shown that the family presence has a bona fide business purpose.
For payments made to independent contractors, the 50% limitation on meal expenses might not apply. If the independent contractor has not fully accounted for the meal expenses, the business would treat the payments as made to the contractor for services rendered. If the meal expenses are fully accounted for, the meal expenses would be 50% deductible by the business.
Business owners and related parties cannot themselves use per-diem amounts to prove their expenses. Owners must provide actual receipts in all circumstances.
If the business owner is reimbursing himself or herself as an employee, separate checks should be written in response to specific reimbursement requests.
There are many potential business expenses that qualify (essentially the normal business expenses the compnay has in running its day-to-day operations). They should be spelled out in the plan and specified in detail for each employee.
SUMMARY
With an accountable plan, reimbursements are not reported as taxable wages compensation income to the employee. The employer avoids payroll taxes. The employer deducts the business expenses in their normal manner. The employee does not have any taxable income to report for the reimbursed business expenses.
With an nonaccountable plan, the company must report reimbursements as taxable wages compensation to the employee on the employees' W-2 form. The reimbursements are subject to federal income tax withholding and social security tax and medicare tax (payroll taxes).
Using an accountable plan is a win-win for both the employer and the employee.
But things have to be done correctly. ALL the requirements must be met in order for it to be an accountable plan.
It's advised to put the plan and the details in writing.
An employer can have an accountable plan for some items and an nonaccountable plan for others. This should again be in writing.
Finally, the company should add the adoption of an accountable plan in their company minutes.
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