Bottom Line Inc

The Best Way to Reimburse Employees

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… and save taxes, too

A business that doesn’t want to give its employees company credit cards, but expects employees to pay for business costs out of their own pockets and later be reimbursed for the expenses, can set up an arrangement that’s a tax win-win situation for both the business and its employees. The arrangement is called an accountable plan.

ACCOUNTABLE PLAN BENEFITS

Reimbursement of employees’ business expenses under an accountable plan means…

  • Reimbursements are not taxable to employees (they are not reported on employees’ W-2 forms). Without this treatment, employees would be taxed on the reimbursements and would be able to deduct expenses only as unreimbursed employee business expenses, which are included in miscellaneous itemized deductions. Miscellaneous deductions equal to the first 2% of adjusted gross income (AGI) produce no tax benefit — only amounts over 2% of AGI are deductible. And even amounts deductible in this way for regular tax purposes are not deductible at all for purposes of the alternative minimum tax (AMT).

  • Reimbursements are not subject to any payroll taxes (they are exempt from income tax withholding, FICA, and FUTA). In contrast, reimbursements under a nonaccountable plan are subject to payroll taxes. So, with an accountable plan, the employer saves on employment taxes as well as administrative costs.

  • The company can deduct reimbursed expenses to the full extent allowed by law (for example, all travel costs and 50% of meal and entertainment costs).

TAX LAW REQUIREMENTS

An accountable plan is an arrangement that meets the following three tax law requirements…

  • The expenses that are covered by the plan must have a business purpose. (The company can’t reimburse an employee for his/her personal expenses.)

  • The employee must adequately account to the company for these expenses within a reasonable time (that is, complete an expense account statement or other record of the expenses, usually within 60 days of when they were paid or incurred).

  • The employee must return to the company any excess advances for business expenses within a reasonable time, usually within 120 days after they were paid or incurred. (Advances can’t be made more than 30 days before the time of the expense.)

    Unlike a qualified retirement plan, an accountable plan does not have to be based on a lengthy, complicated document. A company should…

  • Put the plan in writing (and for corporations, make an entry in the corporate minutes that an accountable plan has been adopted).

  • Give a periodic statement to employees, at least quarterly, telling them to comply with record-keeping requirements and to return any excess advances within the time limit.

CAR AND TRAVEL ALLOWANCES

You can choose to reimburse employees at a fixed rate (set by the government) for their travel and car use. Relying on a fixed rate eliminates the need to save receipts and total up actual costs. The available fixed rates that you can use include…

  • The IRS standard mileage rate for car usage (50.5¢ per mile in 2008).

  • A fixed and variable rate (FAVR) for car usage. This allowance is a combination of variable costs (for example, gasoline and oil) and fixed costs (for example, depreciation and lease payments).

  • The IRS-set high-low rates (two sets of rates — a high rate for areas designated as high cost, and a low rate for all other areas) for travel within the continental US.

  • Federal per diem rates for travel in the US or abroad (regular federal per diem rate), which vary by specific location.

  • The federal standard meal allowance.

    Federal rates can be found at the US General Services Administration Web site (www.gsa.gov). IRS rates are at the IRS site (www.irs.gov). Search by type of rate.

    Caution: Using these fixed rates still requires substantiation for dates, places, and the business purpose of the expense. These rates can’t be used to reimburse business owners for their company-paid expenses or to reimburse those related to the owners (spouses, siblings, children, grandchildren, and certain other relatives) for theirs.

    Note: You can’t create your own per diem rates that exceed the federal or IRS limits — either you use the government rates, or you can use the actual costs if they are greater.

    Example: One courier service had tried to set its own rate for car reimbursements to certain drivers. The rate was based on the charge to the customer based on the distance of the delivery and was within the IRS mileage rate, but drivers could double up (carrying more than one delivery per trip) and effectively drive fewer miles than the actual reimbursements, so a court said “no go” to the company’s plan (Shotgun Delivery, Inc., CA-9, 2001-2 USTC ¶50,700).

ACCOUNTABLE PLAN LIMITS

Accountable plans arose for travel and entertainment costs, but aren’t limited to these types of expenses. Many businesses use accountable plans to reimburse employees for other types of business costs — and some have pushed too far.

Successes…

  • Credit cards and electronic records. A plan is allowed to use paper-less (electronic) record keeping where the credit card company provides the employer with monthly electronic receipts for all charges (reimbursable amounts) billed to employees (Revenue Ruling 2003-106).

  • Pipeline construction industry employees. An employer can pay an hourly rate for rig (a heavy truck with welding equipment) expenses up to $15 per hour if deemed substantiated under accountable plan rules (or up to $9 per hour if fuel is supplied) in 2008 because of the unique features of the industry (Revenue Procedure 2007-66).

Failures…

  • Tools for automotive workers. Tool allowances based on national averages rather than actual employee costs do not meet accountable plan requirements (Revenue Ruling 2005-52).

  • Mileage allowance to couriers. Drivers paid a variable commission (a percentage of a certain company rate minus a mileage allowance that was based on the number of miles traveled times the IRS standard mileage rate) failed to meet the business connection requirement (Revenue Ruling 2004-1).

To be determined…

  • Reimbursements to broker/dealers. Originally, the IRS had approved an arrangement to reduce expected commissions in favor of reimbursements under an accountable plan, but it withdrew its approval and has yet to determine whether a salary reduction can constitute an accountable plan (Letter Ruling 200035012).

    Although it hasn’t yet been officially sanctioned by the IRS, tax advisers have suggested that accountable plans be used for other purposes, such as reimbursing a business owner for use of a home office. This is especially important for S corporation shareholders who cannot deduct the costs associated with the business use of their homes when the space is leased to their corporations.

    Other expenses that can be reimbursed under an accountable plan include uniforms, protective clothing, professional organization dues, subscriptions to business-related publications, computer costs, work-related training, and education expenses.

    Caution: The IRS is looking for abuses in accountable plans. For instance, routinely paying allowances in excess of per diem limits without substantiation is considered an abuse, and all reimbursements under the plan are then treated as having been paid by a nonaccountable plan, not just amounts above the per diem rates (Revenue Ruling 2006-56).

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Source:

Justine DeVito Tenney, CPA/PFS, CFP, partner, private business group, Weiser LLP, 3000 Marcus Ave., Lake Success, New York 11042, www.weiserllp.com. She specializes in closely held businesses and family groups.

Date: July 1, 2008 Publication: Bottom Line Wealth