What are proper Employer Reimbursements to Employees and the Tax Consequences?
Many employers reimburse their employees for business related expenses. Whether this constitutes taxable income to the employee depends on the accounting method used by the employer. There are two plans available:
1. The Accountable and Non-accountable plan.
Accountable Plan:To be an accountable plan, your reimbursement or allowance method must require the employee to meet all three of the following conditions:
1. The employee must have paid for or incurred deductible expenses while performing services for the employer.
2. The employee must adequately account to the employer for these expenses within a reasonable period of time. 3. The employee must return any amounts received in excess of documented expenses within a reasonable period of time.
Amounts paid under an accountable plan are a deductible expense for the employer and are not considered to be wages to the employee. Therefore, amounts paid under this plan are not subject to income, social security, Medicare, or unemployment taxes. Amounts not substantiated through appropriate documentation are subject to all taxes previously mentioned and are reportable in box 12 of the W-2 using code L. Table 5-1 of the Internal Revenue Service (IRS) Publication 463, Travel, Gift, and Car Expenses, provides guidance on what the IRS considers to be adequate documentation of these expenses. For vehicles, if you are to deduct the actual expense of operating the vehicle, you must document the cost of the car and any improvements, the date the vehicle was purchased and the date the vehicle was placed in service. You must also document the cost of any operating expense including gas, oil, maintenance costs, etc and the date such expenses were paid. Whether you use the Standard Mileage allowance or actual expenses, you must document the business purpose and destination of each trip and the mileage for each business trip and the total miles for the year.
Non-Accountable Plan:
Payments to an employee for travel and other business related expenses under a non-accountable plan are treated as supplemental wages and are subject to income, social security, Medicare, and unemployment taxes. An employer pays employees under a non-accountable plan if:
1. The employee is not required to or does not substantiate timely those expenses to you with receipts and/or other documentation, and 2. The employer advances an amount to an employee for business expenses and the employee is not required or does not return timely any amount he or she does not use for business expenses, or 3. The employer pays an amount to the employee without regard for anticipated or incurred business expenses.
According to IRS Publication 15, (Circular E), Employer’s Tax Guide, “Supplemental wages are compensation paid in addition to an employee’s regular wages.” And, as long as supplemental wages do not exceed $1,000,000, they are subject to the same income, social security, Medicare, and unemployment tax as though they were normal wages. So, the decision is, do you want to go to the time and effort to obtain the necessary documentation from your employees. If so, it may be to your benefit to develop and Accountable Plan. If not, be sure that the employee understands that he must report the reimbursement or allowance as income on his tax return and document and maintain expense information to be deducted against this income. The sources used to compile this information include the IRS Publications 15, 463, and 1542, and the instructions for form W-2.
