Businesses can repay employees for business expenses using either an accountable plan or a non-accountable plan. Accountable plans must follow specific rules but offer significant tax advantages.
What Is an Accountable Expense Reimbursement Plan?
An accountable plan is an expense reimbursement arrangement that requires employees to document their expenses and return any they cannot support. Most payments made by an accountable plan do not count as wage income for the employee or generate payroll tax liability for the business.
Treasury Regulation 1.62-2 establishes a three-part test to determine whether a reimbursement plan qualifies as accountable. Accountable plans must have all of the following elements:
- Business Connection. The plan only reimburses employees for business expenses incurred while performing services for the company. An accountable plan cannot repay employees for personal expenses. For expenses partially related to the business—like a vehicle used for both business and personal travel—the plan may only reimburse for the business portion. Only business expenses deductible on the company's tax return qualify for the favorable tax treatment of accountable plans. Nondeductible business expenses—such as meals for employees working overtime—get treated as if made from a non-accountable plan but do not prevent the rest of the plan from qualifying as accountable.
- Adequate Substantiation. The plan requires employees to sufficiently document expenses within a reasonable time. IRS Publication 463 provides guidelines for what the IRS considers sufficient documentation and a reasonable time. Different types of expenses require different documentation by law. Usually, an expense report plus a receipt—or a mileage log for auto expenses—will satisfy this requirement. Most transactions under $75 require just a log or expense report, but you may still want to require receipts from your employees as a best practice. The IRS states that individual facts and circumstances determine what qualifies as a reasonable time for employees to provide documentation. Plans that require expense substantiation within 60 days automatically meet the timeliness requirement.
- Return of Excess Reimbursement. The plan mandates the return of any excess reimbursement over the amount the employee can document within a reasonable time. This usually happens when the business reimburses expenses—often for travel or equipment purchases—in advance. The IRS determines timeliness based on facts and circumstances. Plans that require repayment of excess reimbursement within 120 days automatically meet this requirement if the plan either prohibits advances more than 30 days before the expense or issues quarterly statements of excess reimbursement to employees.
What Is an Expense Report?
Businesses use a form called an expense report for employees—and sometimes partners or shareholders—to report expenses for reimbursement. An expense report records the date paid, vendor name, amount paid, and description for each expense. While not strictly necessary for tax purposes, including totals for each expense category on the expense report makes it much easier for the company to track expenses.
Expense reports come in both paper and electronic forms. Microsoft provides a free expense report template that fits on a single page.
Expense reimbursement plans cannot qualify as accountable plans unless the plan requires the documentation provided by an expense report. However, expense reports offer many other benefits including improving recordkeeping and preventing fraud.
What Are the Tax Consequences of a Non-Accountable Plan?
Non-accountable plans include any plan that does not qualify as an accountable plan. While perfectly legal, non-accountable plans have significant tax disadvantages for both employees and companies.
Reimbursements made under a non-accountable plan count as wage income for employees. This also means the business will incur payroll tax liability and must withhold taxes for these reimbursements.
Establishing an accountable expense reimbursement plan ensures that your company and your employees receive more favorable tax treatment on reimbursements.