Reimbursing Employees for Expenses: Navigating Taxes
In the course of business, it is common practice for employers to reimburse their employees for certain business expenses. Some examples include business travel, meals and entertainment, business use of a personal vehicle, tools and supplies, education expenses and professional dues. The tax treatment of reimbursed employee business expenses is dependent on whether the employer uses an accountable or a non-accountable plan. It is important for employers and employees to understand how the plan is structured and, subsequently, how payments will be treated for tax purposes.
According to the IRS, an accountable plan has several requirements that must be met. First, the expenses must have been paid to the employee or incurred by the employee while performing services for the employer. Second, the employee must be required to provide documentation to the employer to substantiate the business expenses and must do so in a timely manner. Lastly, any reimbursements that exceed substantiated expenses must be returned to the employer in a timely manner. Additional information related to accountable plans are provided by the IRS.
In contrast, a non-accountable plan exists when the employee does not need to substantiate business expenses and is not required to return any excess amounts. For example, an employer may provide an employee with a set amount for expenses while traveling on business. Assume the reimbursement plan provides $75 per day for meals and the employee does not need to provide receipts for expenses. The employee is also not required to return the difference between what he/she actually spends and the $75 allowance. This would be an example of a non-accountable plan. The assumption in this case is that the employee typically will not spend the full allowance and therefore is receiving some form of payment for services. When employees are reimbursed under a non-accountable plan, the payments will be included as taxable income, but may be deductible as an itemized deduction on their personal income tax return. In the example above, the full $75 allowance will be included in the employee's gross income and the actual expenses incurred will be included as an itemized deduction for employee business expense, subject to personal income tax limitations.
Why is it important for employers to understand the difference between an accountable plan and non-accountable plan?
It is important because reimbursements are treated differently for tax purposes under each plan. Business expenses reimbursed under a non-accountable plan are considered income to the employee and must be included as such in the employee's W-2. This type of reimbursement is also subject to employment taxes both for the employee and employer that can include withholding taxes, FICA, and federal and state unemployment taxes.
Employers may consider the additional paperwork a disadvantage to adopting an accountable plan, but an advantage that may offset this additional work is the avoidance of added payroll taxes under the non-accountable plan. Employers may also consider how employees will perceive reimbursements under each type of plan. The accountable plan allows employees to receive reimbursements without any personal income tax effects. The non-accountable plan increases gross income reported to the employee with the option to deduct the business expenses personally. As itemized deductions, the expenses may or may not be deductible depending on the employee's individual tax situation.
Employers should consider the advantages and disadvantages to each type of plan in deciding how to structure the reimbursement of employee business expenses.