How are Expense Reimbursements Taxed by the IRS?
If your business reimburses you or your employees for out-of-pocket expenses, the IRS treats such reimbursements as being made under either an accountable plan or a non-accountable plan. If reimbursements are made under a non-accountable plan, they are taxed as income to the employee and the business will incur payroll tax liability and must withhold taxes for the reimbursements. In order to avoid these negative tax consequences, the reimbursements must be made in compliance with the IRS rules for an accountable plan.
What is an Accountable Reimbursement Plan?
An accountable plan is an expense reimbursement arrangement that is designed to ensure that expense reimbursements made by a business are for legitimate business expenses and that the expenses are properly substantiated. An accountable plan must meet 3 requirements to satisfy the IRS’s standard: (1) the expenses must have a business connection; (2) the expenses must be substantiated within a reasonable period; and (3) the employee must return any excess advance reimbursements, also within a reasonable period. If these requirements are met, the expense reimbursements are not taxable to the owner or employee and the business receives a deduction for the reimbursements.
If any of the three conditions are not met, the reimbursement arrangement is treated as being under a nonaccountable plan and the reimbursement is considered to be taxable compensation to the employee.
What Types of Expenses Qualify Under an Accountable Plan?
To qualify for reimbursement under an accountable plan, the expenses must be incurred or paid in connection with the employee’s performance of service.
Some common types of business-related expenses approved by the IRS include:
- Travel expenses
- Car expenses
- Home office expenses
- Supplies and tool expenses
- Cell phone and internet expenses
- Training, development, dues, and license expenses
Must an Accountable Plan be Made in Writing?
There is no requirement by the IRS that an accountable plan be made in writing. However, it is recommended that all accountable plans be made in writing as a best practice. Having a documented accountable plan allows your business to clearly define its policy and procedure for expense reimbursement, as well as to substantiate compliance with IRS requirements and defend against any potential examination by the IRS.
If you would like more information about creating an accountable plan for your company or if you would like us to review an existing reimbursement policy to confirm it meets the IRS requirements to qualify as an Accountable Plan, please reach out to us at (404) 356-5682.