Business owners who work for their company typically have expense accounts; the same usually is true for many employees.
If your company has what the IRS calls an accountable plan, everyone can benefit from the tax treatment. The company gets a full deduction for its outlays (a 50% deduction for most dining and entertainment expenses), while the employee reports no taxable compensation.
A company expense plan judged to be nonaccountable, on the other hand, will not be as welcome. It is true that the company can deduct 100% of the payments it makes for meals and entertainment, but it also will have to pay the employer’s share of payroll taxes (FICA and FUTA) on the expense money paid to employees. The employees, meanwhile, will report those payments as wages that are subject to income and payroll taxes.
In that situation, the employee can include employee business expenses (minus 50% of those for meals and entertainment) with other miscellaneous itemized deductions, but only miscellaneous deductions that exceed 2% of adjusted gross income can be subtracted on a tax return. Taxpayers who owe the alternative minimum tax cannot get any benefit from their miscellaneous deductions.
In order for expense accounts to get favorable tax treatment, they should pass the following tests:
- Business purpose. There should be an apparent reason why the company stands to gain from this outlay. An employee might be going out of town to see a customer or a prospect, for example.
- Verification. Employees should submit a record of their expenses, in order to be reimbursed. Lodging expenses require a receipt, as do other items over $75.
In order to reduce the effort of dealing with multiple receipts, employers are allowed to give employees predetermined mileage and per diem travel allowances. Substantiation of other elements besides amounts spent (time, place, business purpose) is still required. If the amounts of those allowances do not exceed the amounts provided to federal employees, the process can be considered an accountable plan. (Excess allowance amounts are taxable wages.) Per diem rates can be found at www.gsa.gov/portal/ category/104711.
Example: XYZ Corp. asks a marketing manager, Jill Matthews, to take a two-day business trip to Atlanta to demonstrate new products. The federal rate for Atlanta (lodging, meals and incidentals) on the federal per diem website is $189 per day. As required by the XYZ accountable plan, Jill accounts for the dates, place, and business purpose of the trip. XYZ reimburses Jill $189 a day ($378 total) for living expenses; her expenses in Atlanta are not more than $189 a day. In this situation, XYZ does not include any of the reimbursement on her Form W-2, and Jill does not deduct the expenses on her tax return.
- Refunds. Employees must return any amounts that were advanced or reimbursed if they were not spent on substantiated business activities.
- Timeliness. Substantiation and any required refunds should be made within a reasonable amount of time after the expense was incurred. Those times vary, but IRS publications indicate that substantiation should be made within 60 days and any employee refunds should be made within 120 days.
For a plan to be accountable, reimbursements and allowances should be clearly identified. They can be paid to employees in separate checks. Alternatively, expense payments can be combined with wages if the distinction is noted on the check stub.