May businesses use statistical sampling to verify expense accounts?

• Author: Schiel, Ron

In light of the tax rules for accountable plans under Sec. 62, may a taxpayer conduct an expense reimbursement review of only a statistical sampling (as opposed to 100%) of certain expense reports?

An accountable plan is one that (1) provides reimbursements, advances or allowances for business expenses that are allowable as deductions for expenses paid or incurred by an employee in connection with the performance of services, (2) requires the employee to substantiate expenses covered by the arrangement to the person providing the reimbursement and (3) requires the employee to return any amount in excess of the substantiated expenses. If an employer maintains an accountable plan, it must determine if the employee meets the substantiation requirements. In general, the following elements must be substantiated for meals, entertainment and travel: business purpose, place and date, amount and business relationship (Regs. Sec. 1.62).

Ordinarily, an employee is not required to maintain substantiation for expenses if the employee has made an adequate accounting to the employer. However, if it is determined that the employer's accounting procedures are not adequate, the employee must substantiate his expenses (Temp. Regs. Sec. 1.274-5T(f)(5)(iii)). Accounting procedures will be considered inadequate if the employer does not require employees to make an adequate accounting of their expenses or if the employer does not maintain adequate substantiation.

The IRS will determine the adequacy of an employer's accounting procedures based on the facts and circumstances of each case, including the use of proper internal controls. For example, Temp. Pegs. Sec. 1.274-5T(f)(5)(iii) states that "an employer should require that an expense account be verified and approved by a reasonable person other than the person incurring such expenses."

In Notice 95-50, the Service increased the substantiation threshold under Temp. Regs. Sec. 1.274-5T(c)(2)(iii) from $25 to $75 for certain meals and incidental expenses while travelling. Also, the IRS requested comments on accountable plans. On Mar. 25, 1997, when the Service issued revised Temp. Regs. Sec. 1.274-5T to reflect the threshold increase, it also responded to co-mments, including the following statements.

* De minimis exception to substantiation requirements: "A comment proposed that employees receiving $1000 or less per year in reimbursed expenses be exempted from the requirement to substantiate the elements of the...