The importance of Accountable Plans
Recently, some creative ways of compensating employees with non-payroll expenses have resurfaced and made the rounds. These recommendations circulate around reimbursing for auto expenses, providing uniform allowances, and a few other nuggets. While the concept is a good one, implementing these reimbursements is a ticking time bomb without a properly executed and followed accountable plan.
An accountable plan is an expense reimbursement or allowance arrangement that requires employees to substantiate expenses and return unsubstantiated advances. With the plan, the reimbursements are tax-free to recipient employees. The company can deduct the reimbursements as business expenses. Failure to use an accountable plan for your employee expense reimbursements (including yourself if you operate as a corporation) turns those improperly reimbursed expenses into taxable wages.
In other words, by failing to comply with the accountable plan rules, you turn the tax-free reimbursement into taxable W-2 wages. That’s about as dreadful as it can get -non-taxable into taxable from a simply and avoidable mistake. Additionally, if you have employees who incur business expenses on behalf of your business and you don’t reimburse them, they are simply out that money. The Tax Cuts and Jobs Act (TCJA) denies them a deduction for those business expenses.
To implement an Accountable Plan and provide tax deductible fringe benefits as compensation, there are four requirements:
The plan must provide reimbursements or allowances only for otherwise deductible business expenses that are paid or incurred by employees in connection with performing services for the company.
The plan must require substantiation 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.
The plan must require employees to return any advance that exceeds substantiated business expenses. You treat any unreturned excess amount as additional wages subject to income taxes and federal employment taxes.
Both the substantiation of expenses incurred by employees and the return of any excess (unsubstantiated) advances must occur within a reasonable time period. Facts and circumstances dictate what is reasonable.
Without these elements, you will lose the deduction. That means:
Your corporation reimburses for the expense but does so in violation of the rules.
You now have W-2 income from the improper reimbursement.
You have no personal tax deduction for the proper business expense, so the deduction is lost.
Your corporation pays extra payroll taxes because the proper business expense is now a W-2 wage.
Don’t let this happen to you! If you are a client for our planning or Virtual CFO services, you should have or will have soon an accountable plan implemented for 2022. We will discuss your proper expense tracking process and how we can help.
If you are not a client, feel free to reach out to us directly to discuss how to properly implement an accountable plan for your office.
