There are numerous instances when an employer may choose to reimburse employees for business related expenses. As a result, it is important to understand the different ways expenses may be reimbursed and the tax impact and information reporting for both the employer and the employee. Following are 5 of the most common questions our clients have regarding business expenses and related reimbursement plans.
1. What types of expenses are commonly reimbursed?
Expenses that may qualify for reimbursement include: business travel (airfare, hotel, business mileage other than commuting, parking), business meals and entertainment, business meeting costs, cell phone and internet expenses, home office expenses, business supplies and equipment, required uniforms, training and certifications, and automobile expenses.
2. Are business expenses that are reimbursed to employees considered taxable income to them?
This will depend on whether the employer has chosen to use an accountable plan or a non-accountable plan (see question 3 for more information on these plans)
- Under an accountable plan, the employer will deduct reimbursed expenses as usual on their business tax returns, and the employee will not have any payroll gross up or related deduction to be concerned with.
- Under a non-accountable plan, the employer should include reimbursed expenses in an employee’s gross wages. It is then the employee’s responsibility to file the appropriate tax form (Form 2106 and/or Schedule A) to claim the related deduction on their tax return.
3. How do I know if a reimbursement falls under an accountable or non-accountable plan?
To be considered an accountable plan, the reimbursement and expense must meet the following three rules:
- Employee expenses must have a business connection. Therefore, the expenses must have been paid or incurred while performing services as an employee.
- The expenses must be adequately accounted for to the employer within a reasonable period of time. This includes providing the employer with all the documentation that the employer is required to maintain in their records such as: business purposes of the expense; if a meal, who attended; the date of the expense; where the employee was traveling to or documentation of the mileage; etc.
- Any excess reimbursement received from the employer must be returned to the employer within a reasonable period of time.
Even though an employer may have an accountable plan, some expenses may not meet all three rules. In this case, reimbursements are generally treated as if they have been made under a non-accountable plan. Other items that fall under non-accountable plan rules include excess reimbursements that an employee fails to return to an employer, and reimbursements of expenses to employees that are otherwise nondeductible for the employer (.e.g, personal use of a car).
4. What is a per diem, and does it qualify under an accountable plan?
A per diem is a daily allowance for business expenses that an employer gives to employees to cover expenses when traveling for work. The per diem allowance generally serves as proof of “adequate accounting” under an accountable plan, as long as the following conditions apply:
- The employer reasonably limits payments of expenses to those that are ordinary and necessary in the course of a trade or business.
- The allowance is similar in form and does not exceed the prescribed federal rate.
- The employee proves the date, place, and business purpose of the expenses to the employer within a reasonable period of time.
- The employee is not related to the employer. If this is the case, the employee must be able to prove expenses to the IRS.
5. Is it more beneficial for the employer to operate an accountable plan or a non-accountable plan?
Accountable plans may be costly. Employers bear the burden of reviewing expense reimbursement documentation, and adjusting employee payroll checks accordingly. This situation may be circumvented if the employer elects to utilize allowances or per diems in place of reimbursement for actual expenses. These allowances and per diems may still qualify as reimbursements under and accountable plan, and not be required to be reported as wages to employees.
In contrast, non-accountable plans may be even costlier. First, the employer is required to withhold and pay payroll taxes on the reimbursed expenses that are considered wages. Second, the employees will very likely be subject to a limitation on the ability to deduct the costs incurred due to the treatment on their individual income tax return. To make matters worse, this is often something that employees do not realize until they file their tax return in the following year.
In general, using an accountable plan for reimbursing expenses may take a bit more administrative effort by the employer, but can help simplify reporting and save both the employee and employer taxes. The rules and reporting requirements for expense reimbursements and related plans are complex; if you have questions related to your business, please contact us.