Understanding Accountable Plans

It is common for business owners and employers to reimburse employees for out-of-pocket expenses incurred when performing their job functions. However, not all expenses are reimbursed.

Prior to the Tax Cuts and Jobs Act of 2017 (“TCJA”), unreimbursed out-of-pocket expenses paid by employees were treated as a miscellaneous itemized deduction on an employee’s personal tax return to the extent these out-of-pocket expenses exceeded 2% of the employee’s adjusted gross income. The TCJA suspended the 2% deductibility rule through 2025.

As a result of this suspension, the use of accountable plans became even more beneficial for employers. Expenses paid under an accountable plan are not treated as income to the employee. If not properly reported and documented, business-related expense reimbursements can be considered taxable compensation to employees and therefore subject to applicable payroll taxes. In order to avoid this, employers should ensure they are satisfying the criteria outlined under an accountable plan.

What is an accountable plan? An accountable plan gives employees a reimbursement or allowance for worked-related expenses.

For an employee business expense reimbursement to be considered paid under an accountable plan, the following must be satisfied:

To establish a business connection, the expense must be a valid expense related to the business and paid by the employee in connection with their services as an employee. To be considered “properly substantiated,” the employee must report the details of the expense, such as the amount of the expense, date, place, names of attendees, and a description of the expense.

Although a reasonable period of time is generally a facts and circumstances based analysis, the IRS Fringe Benefit Guide provides “safe harbors” for the length of time that can pass to be considered substantiated within a reasonable period of time. These safe harbor rules also apply to the time frame associated with employees returning excess reimbursements to employers. The safe harbors include the Fixed-Date Method and Periodic-Statement Method.

The Fixed-Date Method states that expenses must be substantiated within 60 days of the expense and any excess advances to employees must be returned to the employer within 120 days of the expense. Under the Periodic-Statement Method, employers provide periodic statements to employees, which include the details of all amounts that have been reimbursed or advanced but not substantiated and require the employee to provide substantiation of the excess amount or return it to the employer within 120 days of the expense.

If the expense reimbursement does not satisfy the criteria above, the plan is considered a non-accountable plan. That said, any reimbursement must be reported as taxable compensation to the employee on their Form W-2 and is subject to Federal and State income tax withholding.

It is recommended that employers maintain a written document outlining their expense reimbursement policy for their employees, as this would give clear guidance on what can be reimbursed, when such expenses need to be reported, the procedure for returning excess reimbursements, and other parts of the policy that can be left to the discretion of the employer, if it follows the rules of an accountable plan. Withum can assist in creating a proper policy that benefits both employers and employees while following the rules set in place by the IRS. The IRS has challenged expense reimbursements in the past, so it is important that a professional who is well-versed in the creation of an accountable plan assist with this.

Accountable plans can entice employees to “get out there” and develop business, in addition to helping employers ensure expense reimbursements will not be treated as compensation subject to employment taxes.

Authors: Jorge Villar | [email protected] and Tony Panico, CPA, MS, Partner and Team Co-Leader, Founders and Tech Executive Services | [email protected]