With the passing of the Tax Cuts and Jobs Act (TCJA) in late 2017, many businesses, business owners, and their advisors are evaluating a variety of topics such as the qualified business income deduction, optimal accounting method for taxation, entity structure, and more favorable fixed asset expensing. However, expense reimbursement policies may be something your company should re-evaluate post-tax reform.
Other than the elimination of entertainment expenses as a business deduction, the TCJA has very little impact on the rules surrounding expense reimbursing, but whether your company’s policy falls under an accountable or nonaccountable plan may have a significant impact on your employee’s personal income tax situations.
Accountable Plan vs. Nonaccountable Plan
For a plan to be considered an accountable plan, it must contain the following three requirements;
- Expenses must be connected to the business,
- Expenses must be substantiated (unless not required under Code Sec. 274(d)), and
- Employees must return any amount received in excess of amounts substantiated.
Any expense reimbursement that does not satisfy the above requirements, would be considered a reimbursement under a nonaccountable plan.
Why Does It Matter?
In general, an expense reimbursement paid under an accountable plan will be a business expense to the company with no reporting requirement to the employee. However, an expense reimbursement paid under a nonaccountable plan is taxable income to the employee (to be included in the employee’s wages) and only deductible to the company as payroll expense. Further, the company would incur additional expenses as a result of the added employment taxes.
Before the TCJA, even if an employee received a reimbursement under a nonaccountable plan they may have been able to offset the additional income reported on their W-2 with an expense on Schedule A of their personal income tax return. However, the TCJA has eliminated the deduction for unreimbursed employee business expenses that previously allowed these expenses to be deducted at the employee’s level. As a result, expense reimbursing under a nonaccountable plan may leave businesses dealing with disgruntled employees come tax time.
Additionally, we often see that companies think their reimbursement policy is in accordance with the accountable plan rules when, in fact, it does not. This could be a result of the policy simply being outdated, or because the company did not consult with its tax advisor when developing the plan. Often, this is not discovered until the company is going through an IRS income or payroll tax examination. In these circumstances, the IRS may re-characterize expense reimbursements as payroll, force the company to pay the employee and employer portion of employment taxes plus backup income tax withholding for the employee, assess underpayment penalties and interest on those taxes, and the employees may need to amend their previously filed personal income tax returns to account for the changes.
What Should You Do?
We recommend consulting with your Blue & Co . tax advisor to determine if your company’s expense reimbursement policy should be modified so that it accomplishes what you have intended it to accomplish. We can help evaluate whether your policy is an accountable plan or nonaccountable plan and recommend any changes as needed.