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Tax consequences of an employee expense reimbursement are determined whether under an
Accountable Plan
or
Nonaccountable Plan.
In general, employee expenses reimbursed under an employer's accountable plan are not considered income to the employee for federal income tax purposes. In contrast, employee expenses reimbursed under a nonaccountable plan are considered income to the employee and are subject to withholding.
If an expense reimbursement or travel allowance plan is found to be a nonaccountable plan,
you have a disaster on your hands.
Why?
1) The employee will have to include his or her expense reimbursements and/or travel allowances as wages (Form W-2) subject to payroll taxes and the employee will be forced to itemize his or her employee business expenses on Form 2106 (and will only benefit the employee if the employee can get over the 2% of AGI floor and if the employee's total itemized deductions exceed the standard deduction for the applicable tax year).
2) Also, the employer now has payroll tax obligations with respect to the reimbursement treated as wages.
An accountable plan is a reimbursement or other expense allowance arrangement that satisfies four basic requirements:
1) business connection;
2) substantiation;
3) return of excess amounts;
4) Timeliness.
The requirements of an accountable plan are applied on an employee-by-employee basis.
To satisfy the accountable plan requirement for a business connection, the business expenses covered by the plan:
(1) must satisfy the requirements for deduction as business expenses; and
(2) must be paid or incurred by the employee in connection with the performance of services as an employee.
Allowances under the plan may include per diem allowances, allowances for meals and incidental expenses, and mileage allowances. It must be reasonable that the employee will be incurring these types of expenses.
To satisfy the second accountable plan requirement of a substantiation component, an accountable plan must require employees to furnish adequate substantiation of reimbursed expenses to the employer or other payor. The specific type of substantiation required under an accountable plan depends on the nature of the reimbursed expense, but in any case must be done in a reasonable amount of time. Certain types of expenditures are covered by other special rules. Such expenditures include:
(1) traveling expenses, including meals and lodging while away from home;
(2) any item with respect to an activity that is of a type generally considered to constitute entertainment, amusement, or recreation, or with respect to a facility used in connection with such an activity;
(3) gifts; and
(4) expenses with respect to any "listed property."
Other than the aforementioned expenses, substantiation is adequate if the information furnished to the employer is sufficient to identify the specific nature of each expense and to show that the expense is attributable to the employer's business activities.
To satisfy the third accountable plan requirement that there be a return of excess amounts, the arrangement must require an employee to return to the employer within a reasonable period of time any amount that exceeds the employee's properly substantiated expenses. If the arrangement contains the requisite provision for return of excess amounts, but an employee fails to return amounts received in excess of substantiated expenses within a reasonable period, the amounts paid to the employee that exceed the properly substantiated expenses are treated as paid from a nonaccountable plan. Special rules apply when an arrangement provides per diem allowances for ordinary and necessary business expenses of traveling away from home (excluding transportation costs to and from the destination) or mileage allowances for ordinary and necessary expenses of local transportation or travel away from home.
Timeliness
Each of the previously discussed accountable plan elements must be met in a timely manner. Even though the regulations indicate that issue of "timeliness" depends on the facts and circumstances of each situation, the safest approach is to rely on a safe harbor contained in the regulations. See Treas. Reg. 1.62-2(g). The safe harbor basically indicates that the plan meets the timeliness requirement if:
1. The employee receives an advance no more than 30 days before they incur the business expenses;
2. The employee substantiates his or her business expenses within 60 days of incurring such expenses;
3. The employee's excess of advances over substantiated expenses is returned to the employer within 120 days of incurring such expenses.
An arrangement between an employer and employee for advances, allowances, or reimbursement of business expenses that does not satisfy one or more of the four basic requirements of an accountable plan is treated as a nonaccountable plan.
For tax purposes, amounts treated as paid under an accountable plan 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 (Federal Insurance Contributions Act ("FICA"), Federal Unemployment Tax Act ("FUTA"), Railroad Retirement Tax Act ("RRTA"), and Railroad Unemployment Repayment Tax ("RURT")), and income tax. They are instead deductible as business expenses by the employer, subject to any limitations on the deduction of the particular type of expense. Note that there are exceptions to this rule for expenses that are either more or less than the reimbursed amounts.
When an employee's expenses are allowed or reimbursed under a nonaccountable plan, the employer must report the amounts paid under the plan as wages on the employee's W-2 Form. Moreover, such amounts are subject to withholding and to the payment of employment taxes, such as FICA, FUTA, RRTA, and RURT.
Amounts paid under a nonaccountable plan are included in the employee's gross income. Expenses attributable to amounts included in gross income are deductible by the employee, as an itemized deduction to the extent that all such deduction exceed 2% of adjusted gross income.
Illustration
John never travels. He asks for an allowance of $3,000 for airfare and hotels. John will not be traveling during the next three months. There is no business nexus or connection between the allowance and this employee's expected job-related travel expenses. John is not going to travel and thus, expects to incur no travel related expenses. The advance/ allowance is made under a nonaccountable plan and the advance will be considered wages paid to John.
Comment: The above illustration has another crucial point imbedded in it. The determination of whether a plan is accountable is discussed in terms of each individual employee. In other words, a reimbursement plan may be accountable as one employee, but nonaccountable as to another employee.
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