Employees often incur business expenses such as travel, business use of their homes, telephone, meals and auto expenses, in the course of their job. Some or all of these expenses may be reimbursed by their employers. There are strict tax rules concerning what qualifies as a legitimate reimbursement and what is considered additional compensation. Under the tax rules the distinguishing factor between additional compensation and a true expense reimbursement is whether reimbursements are made in accordance with an Accountable Plan.
Expenses, other than most meals and entertainment expenses, reimbursed under an Accountable Plan are tax deductible to the employer but not taxable to the recipient. As is generally the case, meals and entertainment are subject to 50% deductibility limit.
To be considered an Accountable Plan, an organization’s reimbursement arrangement must meet the three requirements as mandated by the Internal Revenue Code and the IRS regulations:
- Amounts reimbursed must have a business connection.
- The reimbursed expenses must be properly substantiated.
- Any amounts paid under the reimbursement arrange, which are in excess of the actual expenses incurred must be returned to the employer within a reasonable time.
Business Connection of Expenses: When an employer reimburses and employee for expenses that are otherwise deductible business expenses, that are incurred by the employee during the performance of services. Such expenses may include travel, lodging and meal expenses while away overnight on business.
The deduction for meals and entertainment is generally limited to 50% of the amount paid. The limitation does not apply to expenses incurred by an employee in connection with the performance of services for an employer under a reimbursement arrangement in which the expense is not treated as compensation. However, the 50% limitation of deduction to applies to the employer.
Proper Substantiation: Expenses reimbursed under an Accountable Plan must be substantiated with adequate records within a reasonable time. Adequate substantiation must address the following elements:
- the amount paid
- the date paid
- description of item/service purchased or place traveled
- the essential character of the expense
- for meals entertainment and gift expenses, the titles and other designation of recipients that shows their business relationship to the organization and,
- For meals, proof that an officer or employee was present at the meal.
To satisfy the adequate record requirement for proper substantiation, the following must be kept (i) an expense diary or log, trip sheet statement of expense or similar record, with entries recorded at or near the time of expenditure and, (ii) documentary evidence, such as receipts or paid bills, which in combination are sufficient to establish each element of the expenditure.
Nevertheless, in certain instances receipts are not required. This includes travel and car expenses calculated using the establish federal rates, reimbursements for expenses other than lodging, for an amount of less than $75, or reimbursement for transportation expenses that are not readily available, such as tolls and cab fare.
Returning Amounts in Excess of Expenses: Amounts paid to employees in excess of actual expenses must be returned to the employer within a reasonable time period. The determination of a reasonable time period is dependent on the facts and circumstances. However, the regulation provide two safe harbors (1) the fixed date method, which lays out a 30 day, 60 day and 120 day limit in connection with issuance of advances to employees, substantiation of expense and return of excess reimbursement respectively and (2) the periodic statement method, under which employees are provided periodic statements of an excess advances or unsubstantiated amounts. Periodic statements must be issued at least quarterly and employees must comply with the request therein within 120 days.
We encourage small businesses to implement Accountable Plans, which allows employee owners to recover the costs of certain mixed use items such as home office use, mileage, cell phones, internet, and meals. Accountable plan is relatively simple, reduces the taxable income to the business entity, thereby reducing the taxes paid, with no impact on the employee owner’s income- a rare win-win scenario, compliments of the IRS!
If you need help to establish an Accountable Plan please feel free to contact us. We will help you draft the documents including the associated Corporate Minutes.