How to Set Up and Properly Administer an Acceptable Reimbursement Plan
Accountable reimbursement plans are an excellent way to reimburse your employees.
Set up properly, accountable expense reimbursement arrangements can be a great tax benefit for your small business as well as your employee.
A Reimbursement Plan is an employee reimbursement arrangement or method for reimbursing employees’ business expenses.
There Are Two Methods For Reimbursing Your Employees:
- Nonaccountable Plan
- Accountable Plan
For example, your employee takes a prospective client out to lunch and discusses what your company can do for them. She gets back to the office and turns in the receipt for the meal to you. You then write her check for that amount.
If you do not have an adequate accountable reimbursement plan set up for your employees, you would reimburse them under a nonaccountable plan.
A nonaccountable plan is a reimbursement policy that does not meet all of the requirements for an accountable plan.
Reimbursements paid through this plan are considered taxable income to your employee and must be included in their wages with appropriate tax withholdings or deductions.
So in the example above, the amount of the check you wrote to her would need to be included in box 1 of her W-2 as taxable income under a nonaccountable plan. The TCJA addresses out-of-pocket expenses when it comes to the employee’s return as no longer qualifying as an itemized deduction.
With an accountable reimbursement plan properly set up and administrated, the amount of the check you wrote to her would not be considered income to her would not be included on the employee’s form W-2.
How To Set Up And Administer A Proper Accountable Reimbursement Plan:
To be accountable, your reimbursement policy must comply with the following terms:
- Have a business connection. You can only reimburse ordinary and necessary business or professional expenses that your employees incur solely for the benefit of your company. Examples of such expenses would be those business-related expenses your employee could deduct on their individual tax return.
- Require proper substantiation. In all circumstances, you must require your employees to substantiate their business expenses by providing you with receipts, canceled checks, invoices, mileage or per diem diary or logs, etc. in what is considered a reasonable time.
- Require excess reimbursement to be returned. Any amount paid to your employee that is more than the actual business-related expense is considered an excess reimbursement or allowance and must be returned to your company within a reasonable period of time.
The first requirement listed above is pretty self-explanatory. The business expense that your employee turns in a requests reimbursement for must be for expenses they incurred while doing their job for your company.
Examples Of Proper Reimbursement Items:
- entertainment expenses
- business miles
- tools and equipment.
- Training and certification (if required for the job)
- subscriptions to trade and professional journals
- dues to professional organizations
- work clothes (if required for the job- does not include clothing, such as suits that can be worn outside of the job)
Example Of Improper Reimbursement Items:
- commuting miles
- meals for employees working late (you cannot reimburse an employee for picking up a meal for everyone working late under an accountable reimbursement plan. You can pay for the meal, but do not try to reimburse your employee for an unqualified business expense under the plan)
The second requirement listed above is a very important component of an effective accountable reimbursement arrangement. The IRS requires you to maintain good records and have actual receipts or proper documentation for any expense over $75 (can use this figure to set up a lower limit such as $25 in your plan).
The Documentation Must Include The 4Ws Plus Extras:
- Who was reimbursed and whom were they with … such as with a business lunch?
- Where were they at the time?
- When did the expense occur and how much did it cost?
- What was the business purpose?
Another important component of that second requirement is to require employees to provide adequate substantiation within a “reasonable” amount of time. Usually, the IRS considers “60 days after expenses are paid or incurred” to be a reasonable amount of time.
The third requirement requires you as an employee to ensure your employees return any excess amounts that were paid to them for the legitimate business expense to be returned to the company within a “reasonable amount of time“.
The IRS usually considers “120 days after expenses are paid or incurred” to be a reasonable amount of time.
Remember that all of the requirements listed above must be met for it to be an accountable plan!
See IRS Publication 463 for more information on the requirements of an accountable reimbursement plan.
Some Additional Points To Consider With Your Accountable Reimbursement Plan:
- Although the tax law does not specifically require your accountable expense reimbursement policy to be in writing, it is advisable to have a written plan outlining all aspects of your reimbursement arrangement on file. If you are a corporation is advisable to include your “approved” accountable plan in your official records.
- You have three options in paying your employees for legitimate business expenses with an accountable reimbursement plan. You can reimburse the employee for their purchase; give them an advancement no more than 30 days before the expense; or pay for their business expenses directly.
- You cannot give the leftover funds in your accountable reimbursement plan to any staff member at the end of the year! It would null and void your whole policy. You would then be required to include all reimbursements for the year on every employees’ W-2s as taxable income.
- If you are a small, struggling business, include wording in your accountable reimbursement arrangement that would allow your employee to claim unreimbursed expenses on their personal income tax… if your company could not afford to reimburse those expenses. This wording should include the requirement that you the employer send a written reply to the requesting employee recognizing their claim as a legitimate business expense, but also denying it according to your reimbursement policy on the basis that you cannot afford to issue the reimbursement. The Tax Cuts and Jobs Act addresses the deduction of business expenses.