Employee Expense Reimbursements: Accountable and Nonaccountable Plans
The deduction of employee expenses is restricted because they are subject to a 2% of adjusted gross income (AGI) floor and can only be deducted if the employee itemizes. However, if the employer reimburses the employee under an accountable plan, then the reimbursements do not have to be reported as income by the employee at all. On the other hand, if the expenses are not reimbursed or they are reimbursed from a nonaccountable plan, then they are deductions from AGI and can only be claimed by the employee who itemizes. So if the employee's itemized expenses are less than the standard deduction, then the expenses are not deductible at all. However, moving expenses and employment related expenses of a qualified performing artist are treated as deductions for AGI, thus making them deductible even if the employee does not itemize.
An accountable plan requires that the employee substantiate all expenses by submitting a record, receipts, or any other type of substantiation to the employer. Additionally, any excess reimbursement or allowance must be returned to the employer, which is any amount not recorded as an ordinary and necessary business expense. Generally, records are recorded in a diary or a log. Substantiation is provided by adequate records, which must list the amount of the expense, time and place of travel or entertainment, business purpose, and the business relationship between the taxpayer and any people being entertained or receiving a gift. Additionally, lodging expenses and any other expense of $75 or more must have documentary evidence, such as receipts or credit card statements to support the expenditure; otherwise, the taxpayer may have to provide a written or oral statement of expense details.
If the business data is not provided with the expenses for any given day, then the employee must return the per diem allowance for those days to the employer to maintain the plan as an accountable plan. Excess allowances over the per diem rate are taxable as wages. If expenses exceed reimbursement, then the excess expenses can be claimed on Form 2106, Employee Business Expenses with the net amount claimed as a miscellaneous expense that is subject to the 2% AGI floor on Schedule A, Itemized Deductions. Hence, unreimbursed expenses can only be deducted if the employee itemizes; otherwise, the deduction has no value. Because the deductibility of meals and entertainment expenses is restricted to 50% of their cost, if the employer has not done so, then the employee may have to allocate any excess expenses over reimbursements between meals and entertainment and other expenses.
Example: Allocating Unreimbursed Expenses Between Meal and Non-Meal Expenses
- Total Expenses = $1,500
- Reimbursements = $1,000
- Cost of Meals = 20% of Total Expenses = $300
- Cost of Non-meal Expenses = $1,200
- Allocable Portion of Reimbursement for Meals = $300 × $1,000/$1,500 = $300 × 2/3 = $200
- Allocable Portion of Reimbursement for Non-Meal Expenses = $1,200 × 2/3 = $800
- Unreimbursed Meal Expense = $300 – $200 = $100
- Deductible Amount of Meal Expense = $100 × 50% = $50
- Deductible Unreimbursed Non-meal Expenses = $1,200 – $800 = $400
- Total Deduction = $50 + $400 = $450
- Case 1: Employee earns $50,000 for the year, then $50,000 × 2% = $1,000;
- Since $450 < $1,000, none of the unreimbursed expenses is deductible.
- Case 2: Employee earns $12,000 for the year, so:
- Deduction = $450 – ($12,000 × 2%) = $450 – $240 = $210, but this is only deductible as an itemized deduction, so if the employee only claims the standard deduction, then the $210 is not deductible at all.
As can be seen from the above example, the employee gains the most by having all expenses reimbursed.
Although an employer may only deduct 50% of qualifying meal and entertainment expenses, the employee can be reimbursed for the entire cost under an accountable plan without it being reported as wages. However, reimbursements for the travel expenses of a spouse are treated as wages to the employee unless the spouse has a business purpose for being along on the trip.
For the accountable plan, advance payments, substantiation of expenses, and return of excess allowances must be done within a reasonable time of the actual occurrence of the expenses. The IRS provides safe harbor status for the following periods of time:
- advance payments given within 30 days before the expenses are expected to be paid or incurred;
- substantiation provided within 60 days after the expenses are paid;
- return of excess reimbursements within 120 days after the payment of expenses.
Deemed Substantiation for a Per Diem Allowance
To lessen the documentation and paperwork of expenses, federal law allows a certain amount that does not have to be substantiated if it is equal to or less than the federal allowance. The federal government pays employees a certain amount for lodging and meals and other expenses when a federal employee has to go to a different city to conduct business. The amount that the federal government allows is referred to as the federal per diem rate. If an employer provides a per diem allowance, which is a specific dollar amount per day, then the amount of the expense is deemed substantiated if the allowance is equal to or less than the federal per diem rate. However, the employee would still have to document places, dates, business purpose, and the business relationship of any parties involved in a transaction. The per diem rate for meals covers other expenses including tips for serving people, and laundry and cleaning expenses. The federal per diem rates are published at least annually in IRS publication 1542.
The federal per diem rate varies according to the locality, with more expensive areas having higher rates. Because the cost of lodging varies substantially, there is no per diem rate for lodging, so expense records would have to be kept.
The per diem rules do not apply if the employer and employee are related or if the employee is also a stockholder who owns more than 10% of the company stock. Reimbursements under an accountable plan do not have to be reported as income.
A nonaccountable plan is a plan that does not satisfy the tax rules of an accountable plan, which means that the employer does not require an accounting or a return of the excess allowance to the employer, in which case the expenses must be reported as wages to the employee on Form W-2, Wage and Tax Statement. The employee can deduct the expenses as unreimbursed expenses. However, the employee can only deduct the expenses if they sought reimbursement from the employer, but the employer refused. Most unreimbursed employee business expenses are reported as miscellaneous itemized deductions subject to the 2% AGI floor, and only 50% of meals and entertainment expenses are deductible.
If the employer did require an accounting of expenses and the return of excess allowances, but the employee failed to do so, then the plan is still treated as a nonaccountable plan.
Starting in 2018, under the new tax package passed by the Republicans at the end of 2017, known as the Tax Cuts and Jobs Act, , employees will no longer be able to deduct unreimbursed business expenses like a home office or the business use of a car, so it would behoove employees to seek reimbursements under an accountable plan.
If all of the employee expenses are reimbursed under an accountable plan, then there are no reporting requirements. However if some expenses are unreimbursed under an accountable plan then the employee must report both the reimbursed and unreimbursed expenses on Form 2106, Employee Business Expenses, or Form 2106-EZ, Unreimbursed Employee Business Expenses. Expenses under a nonaccountable plan and employee expenses that are not reimbursed at all can only be deducted as an itemized deduction on Schedule A, Itemized Deductions.