Think Twice Before Reimbursing Your Employees
Posted on December 4, 2019 by Konrad Miernowski
Under the recent Tax Cuts and Jobs Act (“TCJA”), as of January 1, 2018, employees are no longer able to deduct unreimbursed employee business expenses on their individual tax returns for tax years 2018- 2025. Previously, any qualified expenses that employees incurred while on the job could be deducted on their individual tax return subject to a 2% floor of adjusted gross income. This also means that any reimbursements the company makes to the employee will be treated as wages to the employee resulting in higher income taxes. On the company side, since these reimbursements are treated as wages, the company will need to pay FICA (Social Security and Medicare taxes) on any reimbursements. This results in a disastrous situation by taxing an employee and company for reimbursements from business related expenses.
One way that current employers can mitigate this tax trap is to establish an “Accountable Plan” which is a company-wide policy of how reimbursements to employees shall be made as well as other requirements that must be followed by the company and employee.
If a company has a qualified Accountable Plan, then any qualified reimbursements paid to employees are not treated as wages and the company does not pay FICA taxes on these reimbursements. Instead these reimbursements are treated as business deductions and deducted subject to the standard limitations on all business deductions. Moreover, the employees do not include these reimbursements as income and are not taxed on these amounts.
An Accountable Plan must include a few key provisions to be considered a qualified plan. Specifically, the Accountable Plan must contain the following:
- Limit reimbursements only to expenses that have a business connection;
- Require some sort of substantiation such as expense reports, receipts, diary, etc;
- Any advances paid that exceed the actual business expenses must be returned to the company; and
- There must be reasonable time limits imposed on both substantiating expenses and returning any excess advances.
It is important to note that merely having an Accountable Plan is not sufficient. The company and employee must follow what is written in the Plan to prevent the IRS from disqualifying the Accountable Plan which would treat the reimbursements as wages to the employee. For instance, if the Plan requires substantiation of expenses within 60 days, the company should strictly enforce this requirement and educate their employees of the requirements of this Plan.
S corporation owners that are also employees should also pay close attention and determine if a qualified Accountable Plan is in place. Since these S corporation owners will be treated as employees, any reimbursements made in the future without a qualified Accountable Plan will result in negative tax treatments. It is common for S corporation owners/employees to advance funds to the company or make business expenses using personal funds making this new change in the law a potential tax trap.
Accountable Plans can be very beneficial to both employees and companies if reimbursements are made by the company. If your company does not have a current Accountable Plan or has questions about whether their existing Accountable Plan is qualified, the attorneys at Lasher Holzapfel Sperry & Ebberson are happy to help.