Employers frequently provide expense allowance accounts for their employees to incur business expenses on behalf of the company. An allowance arrangement does not require the employee to submit receipts in order for reimbursement. These are considered ‘unaccountable’ expense reimbursement plans and if they are used after 1/1/18, amounts paid to the employee will still be included in his taxable income, but he will not be able to claim a deduction for them as an employee business expense on his personal income tax return. That’s because the 2017 Tax Reform Act eliminated an individual’s ability to a claim a deduction for unreimbursed employee business expenses, and as a result, employers may be passing an expenditure on to an employee that they can no longer deduct.
Employee business expenses reimbursed under an employer’s accountable plan are not treated as income to the employee for federal income tax purposes and the company is able to claim the deduction for the business expenses instead of the employee.
An accountable plan is a reimbursement or other expense allowance arrangement that satisfies three basic requirements:
- The expense must have a business connection
- Substantiation for the expenses should be provided within a reasonable timeframe, and
- The employee must return any excess monies that are not reimbursements for deductible expenses to the employer
To satisfy the business connection element, the expenditure must qualify for deduction as a business expense and be paid to an individual who performs services as an employee. The plan can provide for federal per diem allowances, including allowances for meals and incidental expenses and mileage allowances.
In meeting the substantiation requirement, an accountable plan must require employees to furnish adequate information for reimbursed expenses to the employer (i.e. date, time, place amount and purpose for the expense). The specific type of substantiation required depends on the nature of the reimbursed expense and must occur within a reasonable amount of time from when the expense was paid. The substantiation requirements are met if the employer can identify the nature of each expense and prove that the expense is attributable to the employer’s business activities.
Return of Excess Amounts to Employer
To satisfy the requirement that excess amounts be returned to the employer, an accountable arrangement must stipulate in the plan document that the employee is required to return excess amounts to the employer within a reasonable period of time. If an arrangement exists, but an employee fails to return excess amounts within a reasonable time period, the excess amounts are treated as if they were paid from a non-accountable plan. That is, they are included in the employee’s income and subject to income tax withholding.
What we like about amounts treated as paid under an accountable plan is that they are excluded from the employee’s gross income and are not reported as wages or other compensation on Form W-2, nor subject to withholding or employment taxes. They are generally deductible as business expenses by the employer.
As noted previously, when an employee’s expenses are reimbursed under a non-accountable plan, the employer must report the amounts paid as wages on the employee’s Form W-2, and such amounts are subject to federal income and employment taxes.
Prior to the 2017 tax reform act, the employee was able to deduct employee business expenses that were included in gross income as an itemized deduction. Now that this deduction has been deferred, employees will need to include these reimbursements in income without the possibility of an offsetting deduction. Employers should consider changing the way they treat reimbursements and start using an Accountable Employee Reimbursement plans, in order to avoid passing this unfair tax burden on to their employees.
One last item to note, although there is no specific requirement to submit a written plan to the IRS, the employer is required to document reimbursed transactions and maintain adequate records demonstrating that the requirements for an accountable plan were met.
If you have any questions regarding your Employee Reimbursement Plan, please feel free to contact your tax professionals at MKS&H.
Article Contributed by Kathleen Davis, CPA
About MKS&H: McLean, Koehler, Sparks & Hammond (MKS&H) is a professional service firm with offices in Hunt Valley and Frederick. MKS&H helps owners and organizational leaders become more successful by putting complex financial data into truly meaningful context. But deeper than dollars and data, our focus is on developing an understanding of you, your culture and your business goals. This approach enables our clients to achieve their greatest potential.