As an employer, there are times when employees may need to be reimbursed for expenses related to travel, meals, continuing education and other expense types (not including health insurance).

The method of documenting these reimbursements can have a significant impact on the tax treatment of these reimbursements. Under current IRS rules, there are two ways to reimburse employees for these types of expenses – an accountable plan and a nonaccountable plan.

A nonaccountable plan is considered income to the employee and is subject to federal withholding. This includes flat-dollar allowances, cents-per-mile reimbursements that exceed IRS standards, and advances.

The advantage of this plan is that it reduces the record-keeping responsibility and simplifies the administrative procedure. However, an employer who is reimbursing an employee under this plan must report the amounts paid as wages on the employee’s W-2 Form and the reimbursements are also subject to payroll taxes. For this reason, most employers generally stay away from this type of plan.

An accountable plan is a reimbursement or other expense allowance arrangement that is not considered income to the employee for federal income tax purposes. The reimbursed amounts are excluded from the employee’s gross income, are not reported as wages or other compensation on the employee’s Form W-2, and are exempt from the withholding and payment of employment taxes. This plan may be ideal for small businesses that do not have many and/or regular employee reimbursement expenses.

In order to be considered an accountable plan, an expense reimbursement plan must meet three requirements and if it does not satisfy one or more of these, it is treated as a nonaccountable plan.

These requirements include the following:

1. Business connection. The expense must satisfy the requirements for deduction as business expenses and must be paid or incurred in the performance of services as an employee of the employer.
2. Substantiation. The employee must provide the employer with evidence of the amount, time, place, and business purpose of the expense within a reasonable period after they are paid or incurred. In other words, the employee has to submit receipts.
3. Returning excess amounts. Amounts paid by the employer to the employee that exceed amounts spent by the employee must be returned to the employer within a reasonable period of time.

A vital detail that some employers may forget is that even if you have an accountable plan, if the employee fails to properly substantiate the expenses within a reasonable time, or the employee fails to return excess amounts, then any reimbursements could become taxable income. It is best to establish some sort of written plan, whether it be accountable or nonaccountable, to save your employees time and alleviate any confusion.
 
Chad Wouters, CPA joined Earney & Company in December 2006 and became the tax partner in November 2013. With an emphasis on strategy and planning, Chad works with his clients all year to ensure the most efficient tax strategies are put into place.  Earney & Company, L.L.P.  is a CPA firm that handles tax compliance, consulting and planning as well as audit and other assurance services.  For more information please visit www.earneynet.com or call (910) 256-9995.  Chad can also be reached at [email protected].