Create an Accountable Plan to Reimburse Employees for Business Expenses
October 29, 2018 | IRS Regulation
One of the changes in the Tax Cuts and Jobs Act (TCJA) was to eliminate itemized deductions for employees who incur unreimbursed expenses for company business for 2018 through 2025. To minimize the adverse effects of this TCJA, you can set up a so-called “accountable plan.” Here’s how the accountable plan deal works and why your Maine-based company should consider one.
Playing by a New Set of Rules
Prior to the TCJA, employees could claim an itemized deduction for unreimbursed business expenses to the extent they exceeded 2% of the employee’s adjusted gross income (AGI) when combined with other miscellaneous expenses subject to the 2%-of-AGI deduction threshold. Some examples of unreimbursed business expenses included union dues, professional association membership fees, work clothes, and cleaning expenses for work clothes. Other miscellaneous expenses that these could be combined with included investment expenses and fees for tax advice and preparation.
After the TCJA, all of these deductions for miscellaneous itemized expenses and unreimbursed business expenses subject to the 2% floor are repealed through 2025.
If your employees will continue to pay out of pocket business expenses on behalf of your company, consider setting up a so-called “accountable plan” to reimburse them. By doing so, the company can deduct the reimbursements (subject to the 50% deduction disallowance rule for reimbursed meal expenses). Plus, the reimbursements will be tax-free to recipient employees.
Reimbursements count as additional taxable wages without an accountable plan. Accordingly, your employees would have income taxes and withheld FICA taxes on the reimbursements while the company would have to pay the employer’s share of Social Security and Medicare taxes on the reimbursements.
Following the Rules for Accountable Plans
An accountable plan is an expense reimbursement or allowance arrangement that requires employees to confirm expenses and return unsubstantiated advances. Generally speaking, employers do employee expense reimbursement plans on a company-wide basis. But the tax rules are applied on an employee-by-employee basis. Thus, one employee’s reimbursements could be under the favorable accountable plan rules, while another employee’s reimbursements fall outside those rules because the accountable plan requirements weren’t met.
To be specific, the following four requirements must be met by an accountable plan:
The business connection requirement. Reimbursements or allowances may only be provided for otherwise deductible business expenses (subject to the 50% deduction disallowance rule for meals). The expenses must be paid or incurred by the employee in association with performing services for the company.
When the employee is paid, the reimbursements or allowances must be clearly identified as such. They may be paid with separate checks, or if paid together with wages, the reimbursement or allowance amount should be shown on the employee’s check stub.
As the TCJA has permanently disallowed deductions for business entertainment expenses, you shouldn’t cover them with an accountable plan. Instead, employees should be provided with a method so they can charge these expenses directly to a company account. While the expenses will remain nondeductible, it will simplify matters by removing your employees from the loop of tricky tax rules.
The adequate substantiation requirement. The plan needs to require corroboration of reimbursed expenses via an expense report, diary, log, trip sheet, detailed receipt or similar record within a reasonable period after the expenses are paid or incurred. Generally, a receipt or other documentation is required for lodging expenses of $75 or more.
The documentation should include:
The amount and business purpose of the expense,
The time and place of any travel,
The date and description of any business gifts, and
The business relationship to the company of each person receiving a gift.
For travel expenses, an accountable plan can base reimbursements on the federal per diem rates for meals, lodging, and incidentals. No substantiation of actual amounts is required if federal per diems are used. Filler & Associates can provide a list of federal per diem rates in the continental United States, as they vary by location and date.
The employee can keep the excess if an employer’s per diem allowance exceeds the applicable federal per diem rate. However, any excess is treated as additional wages subject to income taxes and federal employment taxes.
The return of excess advances requirement. Employees must be required to return any advance that exceeds substantiated business expenses by the plan. Any excess amount that is unreturned is treated as additional wages and subject to income taxes and federal employment taxes.
If the company pays a per diem travel allowance that doesn’t exceed the federal per diem rate, employees can retain any excess of the per diem allowance over actual expenses (in other words, “keep the change”). This will not disqualify the accountable nature of the plan or require any excess to be treated as additional taxable wages. In comparison, a plan that reimburses for actual expenses must require employees to return all excess advances to qualify as an accountable plan.
The reasonable time period requirement. Both the substantiation of expenses incurred by employees and the return of any excess (unsubstantiated) advances must happen within a reasonable time period. “Reasonable” is determined by facts and. For example, an employee on an extended out-of-town assignment would have more time to substantiate expenses and return any excess amounts.
Simplifying Matters with Safe Harbors
IRS regulations offer two safe harbors if you want certainty in meeting the reasonable time period requirement.
Fixed-date method. Under this safe harbor, the reasonable time period requirement is met automatically if the plan specifies that:
Advances will be made no more than 30 days before the employee pays or incurs the anticipated expense for which the advance is made.
Expenses must be substantiated within 60 days after they’re paid or incurred.
Advances for unsubstantiated amounts must be returned to the company within 120 days.
Periodic-statement method. Under this safe harbor, the reasonable time period requirement is automatically met if the plan stipulates that the company will:
Provide affected employees with statements, no less than quarterly, of the amount of advances that haven’t yet been substantiated, and
Request that any such advances either be substantiated or returned to the company within 120 days after the statement is issued.
Time to Switch?
Under the current tax rules, there is a clear benefit to accountable plans for employees with unreimbursed business expenses and to their employers (because the employer’s share of federal employment taxes is avoided). If your employees pay out of pocket for business-related expenses, contact Filler & Associates to see if an accountable plan is right for your company.