Ever have an employee take a client or prospect out for lunch? Unless they’ve got a corporate credit card, they’re going to be paying with their own funds. Many employers reimburse for these out of pocket expenses. How the reimbursements are treated for tax purposes, though, can be a little complicated. Companies can either have an accountable plan or a non-accountable plan. Employees may have to pay income tax on any reimbursements paid depending on which plan your company is using.
Do you require your employees to turn in receipts for expenses before reimbursing them? If so, then you are using an accountable plan at your office. In order to qualify as an accountable plan, the policy must include the following three conditions:
1) The expenses must have a business connection;
2) There must be adequate documentation of the expense provided within a reasonable period of time; and
3) Any excess reimbursement must be returned within a reasonable period of time.
The IRS doesn’t specifically define what is considered a reasonable period of time; it depends on the facts and circumstances of the situation. The biggest benefit of having an accountable plan is that your employees don’t include the reimbursements as part of their wages on their income tax returns. Accountable plans also apply to companies that offer allowances to their employees instead of reimbursements.
The other option for companies is to offer a non-accountable plan. Under this type of plan, employees are not required to submit expense receipts or pay back any excess reimbursement. An easier way to think about it is that if a plan doesn’t qualify as an accountable plan, it’s a non-accountable plan by default. Any amounts paid under a non-accountable plan will have to be included in their wages. As a result, they will have to pay income taxes on this amount. Clearly, this treatment isn’t as beneficial as an accountable plan for the employee. The employee will have to deduct the expenses on Form 2106 on his or her tax return. Unfortunately, if the employee doesn’t itemize deductions than he or she won’t be able to take any deductions against the reimbursement.
If you’ve got employees paying for expenses out of their own pockets, you need to have a policy in place on reimbursements. The type of plan in place will determine whether or not your employees will have to pay tax on the reimbursements or allowances you provide. An accountable plan avoids taxing the reimbursements, and is preferred by employees.
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Associate Partner
Ren III provides tax, accounting, and advisory services to a broad range of clients, with a specialty for manufacturers, title insurance companies, and professional service providers.
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