As an employer or an employee one intricacy of tax laws and regulations that often goes unnoticed is the concept of Accountable Plans. These plans, when implemented correctly, can provide significant tax benefits for both employers and employees.
Under the Tax Cuts and Jobs Act (TCJA) signed into law by President Trump in 2017, the rules for deducting the rules for deducting employee business expenses changed significantly. Prior to the TCJA, employees could potentially deduct unreimbursed business expenses as miscellaneous itemized deductions on their personal income tax returns.
However, for tax years 2018 through 2025, the TCJA suspended the ability for employees to deduct unreimbursed business expenses as an itemized deduction. This includes expenses such as local business transportation and away-from-home travel expenses.
An accountable plan provides a way around the TCJA deduction restrictions. Accountable plans are reimbursement or allowance arrangements that meet the criteria set by the IRS. These plans allow employers to reimburse employees for business-related expenses without the reimbursement being considered taxable income. There are benefits for both employer and employee:
- From an Employer’s Perspective – The benefits for employers are twofold. First, reimbursements under an Accountable Plan are not subject to payroll taxes. This means employers can save on their share of FICA (Social Security and Medicare) taxes, which can add up to substantial savings. Second, these reimbursements are deductible as business expenses, further reducing the company’s taxable income.
- From an Employee’s Perspective – For employees, reimbursements under an Accountable Plan are not considered taxable income. This means they do not have to report these reimbursements on their income tax returns. There’s also no FICA tax withholding for the reimbursement received by the employee. As a result there’s significant tax savings for employees, especially those who frequently incur business-related expenses.
However, to qualify for these benefits, the plan must meet three criteria set by the IRS:
- Business Connection: The expenses must be incurred while performing services as an employee.
- Substantiation: Employees must provide their employers with documentary evidence of these expenses within a reasonable time.
- Returning Excess Amounts: If an allowance exceeds the substantiated expenses, the excess must be returned within a reasonable time.
Accountable Plans can be a win-win for both employers and employees. They provide a way for employers to reimburse employees for business-related expenses without increasing their tax liability. At the same time, employees can receive these reimbursements tax-free, leading to significant tax savings.
However, setting up and maintaining an Accountable Plan requires an understanding of IRS regulations. It’s crucial to ensure that the plan meets all IRS criteria to avoid potential tax penalties.
Here’s a very basic example of what an accountable plan might look like:
[Your Company Name] Accountable Plan
- Purpose: This accountable plan is established to govern the reimbursement of business expenses incurred by employees on behalf of [Your Company Name]. The plan is intended to comply with all applicable IRS regulations.
- Business Connection: Reimbursements are only made for expenses that are directly related to the business of [Your Company Name]. Employees must incur these expenses while performing services as an employee.
- Substantiation: Employees must provide [Your Company Name] with detailed records of the expenses. This includes the amount, date, place, and business purpose of each expense. Employees must also provide receipts for any expenses over $75.
- Returning Excess Reimbursements: If an employee receives an advance or an allowance for business expenses, they must return any amount in excess of the actual expenses within a reasonable period. [Your Company Name] defines a reasonable period as 60 days after the expense was paid or incurred.
- Noncompliance: If an employee does not comply with the rules of this accountable plan, [Your Company Name] may include the amount of the reimbursement or allowance in the employee’s income.
- Amendments and Termination: [Your Company Name] reserves the right to amend or terminate this accountable plan at any time.
Please note that this is a basic example and may not cover all the necessary specifics appropriate for your business. It is highly recommended additional detail such as the following be added:
• Date the plan becomes effective.
• Type of expenses reimbursable under the plan.
• Extent to which supervisory approval of expenses is required.
• Cost limits applicable to the different types of expenses.
• Overall periodic limits on periodic reimbursable expenses.
• Time limits for submitting expense requests.
• The procedures for submitting requests.
• Required documentation by type of expense.
• How and when excess reimbursements must be returned.
• If applicable, a list of preferred suppliers.
If you have more questions about Accountable Plans or need a consultation to customize your plan, please contact our office in Leesburg at 703-771-1818 or in Warrenton at 540-347-5681.