Small business owners who reimburse themselves or their employees for business expenses are subject to IRS rules that must be followed or risk financial consequences for both your company and your employee. Having a clear set of internal guidelines can save you and your staff from unwarranted problems such as a hefty tax bill. Your guidelines should include explanations of what expenses are deductible and under what circumstances. You should also provide clear guidance for your employees about what sort of supporting documentation you require for reimbursement.
A World of Difference
The IRS draws a very sharp line between an employee business expense reimbursement plan that is “accountable” versus one that is “non-accountable”. Expenses reimbursed under an accountable plan are tax deductible to the business and are not considered income to the employee. Reimbursed expenses under a nonaccountable plan are considered taxable wages to the employee and you are required to remit payroll taxes on the amount paid. IRS rules allow you to have both accountable and non-accountable reimbursement plans at the same time.
These are plans where an employee is reimbursed for actual expense or is given an allowance to cover expenses. To qualify it must meet certain conditions.
A business condition for the expense must exist.
- This means the expense must be incurred as part of the employee’s performance of services. In order to qualify, the expense must be one that the employee would be able to deduct from their taxes if they were not reimbursed.
The expense must be substantiated or deemed substantiated.
- For an expense to be considered substantiated, documentation is required. Documentation can include; receipts, cancelled checks, and invoices that include a description and the amount paid.
- For an expense to be deemed substantiated it must be disbursed as an allowance such as mileage ($.56 per mile) or a per diem rate for overnight travel. These may be used in place of receipts.
Overpayments must be repaid.
- The IRS requires that the employee return both substantiated and deemed substantiated reimbursements that were greater than the actual expense within a reasonable time. There are two ways to calculate what a reasonable time is. If you provide at least quarterly statements your employee must return any amount that they cannot provide documentation for within 120 days of the statement date. Excess advance expense payments must be paid back within 30 days.
Nonaccountable Plans and Unreimbursed Expenses
You may choose to reimburse some expenses and not others or to reimburse expenses on a non-accountable basis. In these cases, your employee may be able to deduct those expenses on their tax returns. In order for an employee to utilize the deduction for unreimbursed employee business expenses they must prepare an itemized return and complete a Schedule A.