You’re checking out at Staples, Office Depot, Kinko’s, or another unexciting yet important local store that caters to businesses. Pulling out your wallet, you notice that your business credit card is missing. Oops! Since you don’t want to leave the cashier hanging, and you do want the goods (and they’re all legitimate business expenses), you run your personal card and make a mental note to reimburse yourself later.
After all, businesses regularly reimburse their owners or employees for legitimate business expenses, whether those purchases were planned or not.
But the IRS isn’t going to like it if you mix business and personal expenses willy-nilly. You need to have some kind of consistent system for ensuring that that there aren’t any unqualified expenses or reimbursements that slip through the cracks. This consistent system would be called an Accountable Plan.
The good news is that the IRS has already established standards for an accountable plan. All you need to do is follow them consistently. We can’t stress this enough: Be consistent.
If this sounds less exciting than a trip to Office Depot, just remember that the IRS has the power to disallow tax deductions if your accountable plan is not up to snuff. That means you lose money. The Federal Government also has the power to decide whether amounts paid to employees are subject to payroll tax. If your accountable plan is faulty, your employees could end up paying income and payroll taxes on reimbursements. This would also lose your company money for the employer portion of payroll taxes.
[As an aside, the new Tax Cuts and Jobs Act (TCJA) has disallowed tax deductions on unreimbursed business expenses, which means that if you don’t reimburse your employees, they no longer have a recourse to get something back from the Federal government at tax time.]
Now that we’ve established the Why of accountable plans, let’s get into the How.
How Do I Set Up an Accountable Plan?
The goal of an accountable plan is to substantiate expenses incurred on behalf of the business in order to accurately reimburse the payer.
Substantiating an expense involves recording and keeping the:
- Dollar amount of the expense
- Business purpose of the expense
- Time and place of travel
- Date, description, and the business relationship to the company of the gift’s recipient (for business gifts)
(Remember: entertainment expenses aren’t deductible.)
When reimbursing the employee, ensure that the reimbursement is stated separately from the employee’s regular compensation. This can best be done by submitting an off-cycle payroll.
If using federal per diem rates for travel, substantiation might not be required for all expenses… but if you have receipts, it can’t hurt to keep them anyway. If your per-diem rate exceeds federal per-diem standards, then the excess will be taxed as regular wages.
If an employee is paid too much reimbursement by accident, then the employee must return the extra amounts or the excess amounts will be taxed as regular wages — although we assume you have other important concerns if an employee refuses to return reimbursement overpayments.
Timing the Repayment
People who substantiate expenses for reimbursement must be subject to restrictions on how long they have to substantiate. If Doug hands you a dirty, torn receipt from April 1996 for a K-mart wrench, you don’t have to pay him back. Look Doug, if you wanted the $3 then you should have substantiated back in 1996.
There are two “safe harbor” methods to ensure that the IRS won’t ding you for mishandling your substantiation time windows:
- Fixed dates: Advances won’t be made more than 30 days prior to the date of the expense. Substantiation must be received within 60 days of the expense. Unsubstantiated reimbursements must be returned within 120 days.
- Statements: Periodically (at least once a quarter), the company provides each employee with a statement showing unsubstantiated expenses. The employee must substantiate or return any amounts within 120 days of the statement.
You can certainly have more stringent requirements than the minimum IRS requirements. For example, you can require substantiation within 30 days if 60 days seems too long (it is long enough to lose track of quite a few receipts). Choose standards that make sense for your company, so long as they also satisfy IRS requirements.
Special S-Corporation Addendum
Do you have an S-Corporation? If so, then there’s more to say about accountable plans. For example, what do you do when you pay for something that is partly used for business and partly for personal use? Examples would be your car, cell phone, or internet plan.
It’s important here to determine what percentage of the time the expense is for business use. Multiply that percentage by the total expense to get the reimbursement. For example, if your internet plan is $100 per month, and you determine that you use it for work 30% of the time, then you can reimburse yourself for 30% * $100 = $30 per month.
When using a vehicle, you have two options. You can use your actual business mileage multiplied by the standard federal mileage rate (currently 57.5 cents per mile, down slightly from 2019). Or you can tally up your actual auto expenses, then multiply them by the percentage of business miles over total miles. If you drive 2,000 miles for business out of 10,000 miles on your odometer in 2020, then you can either deduct $1,150 at the standard rate or 20% of your actual expenses. If your actual expenses were $5,000 then you’d be better off deducting standard miles at $1,150 than at 20% of $5,000 = $1,000.
Another important aspect to consider with S-Corporations is that you are an employee. This means that any expenses you pay on behalf of your business can be reimbursed to you as they would be to any employee, instead of being booked as distributions. If you’re wondering why this matters, the answer is that reimbursements reduce your company’s income as opposed to distributions, which only affect equity.
If you are able to reduce your S-Corp’s income, then it can save you tax dollars after year-end!
TL;DR: If you reimburse anyone for business expenses (including yourself), you must adhere to IRS requirements for accountable plans. The IRS really isn’t asking for much: just enough evidence so that they can make sure you’re not cheating the system. Be consistent with your accountable plan! Also note that there are special circumstances for S-Corporations and reimbursements.
Do you have any questions about your accountable plan? If so, you can schedule your first appointment here! We’re happy to help.