Employers who reimburse employees for job-related expenses should give serious consideration to having an accountable expense reimbursement plan in order to save both employer and employee taxes. Here are the details:
TAX BACKGROUND
A reimbursement of job-related expenses to an employee is not taxable if the payment is made pursuant to an “accountable expense reimbursement plan.” If the expense reimbursement is not made by an accountable plan, such as an “allowance”, the reimbursement is taxable for both income and payroll taxes to the employee. The tax code specifically addresses “accountable vs non-accountable” expense reimbursement plans in IRC 62(c) and IRS Regulation 1.62-2
MORE IMPORTANT IN 2018 THAN EVER BEFORE
The Tax Cuts and Jobs Act (new tax law effective January 1,2018) eliminates personal income tax deductions for employees/individuals who have unreimbursed business expenses. For decades prior to 2018, an individual could claim a personal income tax deduction for job-related expenses on their personal income tax returns, as a “miscellaneous itemized deduction.” The new tax law has eliminated tax deductions on personal income tax returns for unreimbursed employee business expenses.
TAX SAVINGS FOR BOTH EMPLOYER AND EMPLOYEE
If an employer provides an “auto allowance” of $6,000 per year to an employee, along with an “allowance” of $2,000 for tools/supplies, without an “accountable expense reimbursement plan,” the employee would be taxed on the $8,000 in their W-2 and would owe about 25% in taxes or $2,000 in this example. The employer would also pay “matching” FICA/medicare tax of 7.65% on $8,000 of wages, or $612 in added payroll tax expense. On the other hand, IF the employer reimburses an employee $8,000 for business use of a vehicle and tools/supplies pursuant to an “accountable plan,” the employee would pay zero tax on the expense reimbursement and the employer would also not need to “match” the FICA/medicare tax.
WHAT ARE THE COMPONENTS OF AN ACCOUNTABLE EXPENSE REIMBURSEMENT PLAN?
IRC Section 62(c) and IRS Reg 1.62-2 defines an accountable expense reimbursement plan as an employee expense reimbursement plan which includes 3 components:
- The expenses being reimbursed must be “business expenses” incurred while performing services as an employee. Business use of a vehicle, tools, supplies, cell phone expense, etc , if used to further the employer’s business purposes, are types of “business expenses;
- The employee must document/”prove” and substantiate the business purpose of the expenses, so that the employer knows they are related to their business, and the substantiation for the expenses to be reimbursed must be given to the employer within a reasonable time period; and
- Any “excess reimbursements/advances” must be returned to the employer by the employee within a reasonable time period. Excess reimbursements are most common when an employer advances an employee funds for out of town business, with “accounting” for the use of the advanced expenses occurring later.
The IRS does not require that the accountable expense reimbursement plan be in writing, BUT it is advisable that the employer does prepare a written document to support the “accountable expense reimbursement” intentions for the plan, and also to communicate the employer’s reimbursement policy to the employee.
WHAT ARE REASONABLE TIME PERIODS AS THE PLAN REQUIRES?
The IRS has ruled that an employee should provide expense documents to the employer within 60 days of when the expense is actually incurred. As to repayment of excess reimbursements from expense account advances, the IRS has ruled that the excess funds be returned to the employer within 120 days of when the expenses were incurred.
WHAT TYPES OF DOCUMENTS ARE NEEDED FOR SUBSTANTIATION OF EXPENSES
Receipts, business driving logs, etc can be used by an employee to substantiate expenses for an accountable expense plan. As a general rule, “who, what, why and where” details as to the business expense are needed for an accurate accounting to an employer.
EXAMPLE OF A WRITTEN ACCOUNTABLE EXPENSE REIMBURSEMENT PLAN
Attached is a copy of an accountable expense reimbursement plan written plan document which was drafted by the Boy Scouts of America (found online). Employers can use this example of a written plan document to prepare their own “accountable expense reimbursement plan.” We recommend that the plan be authorized by the employer-organization’s corporate officers or board, with a “resolution” to adopt the plan signed by the officers or owners of the employer-organization.
IN CLOSING
Accountable expense reimbursement plans are the “tax-smart way” of reimbursing employees for business expenses which benefit the employer. Expenses paid to employees pursuant to an “accountable plan” do not appear on the employee’s W-2 form, even if they are paid through the payroll process (by adding them to employee paychecks)
If you need help in drafting an accountable expense reimbursement plan, feel free to contact a CPP/CPA at AccuPay at 317-885-7600
We have a number of forms that are available to help you through this process. You can easily download any of them here!