How accountable plans save employers when reimbursing employees: basics for tax-favored expenses vs. taxable compensation.

• Author: Barnett, Michelle
• Position: FINANCIAL SERVICES

When an employer pays an expense reimbursement or advance to an employee (regardless of whether the employee incurs or is reasonably expected to incur the expense), the IRS considers the arrangement to be disguised taxable compensation to the employee. In other words, the purported expense reimbursement is treated as additional taxable compensation.

But when the employer makes these payments under a so-called "accountable plan," they're free from federal income and employment taxes for recipient employees. Additionally, the employer benefits because the reimbursements aren't subject to the employer's portion of federal employment taxes.

Accountable Plan Basics

Accountable plans are required to meet four requirements in order for payments to recipient employees to qualify as tax-favored expense reimbursements, rather than taxable compensation:

1. Business Connection: Reimbursements or allowances can be paid only for expenses incurred by employees in connection with performing services for the employer. A common example is business-related travel expenses.

2. Substantiation: Expenses must be substantiated by an expense report or similar record. Receipts should be required for expenses over $75. For lodging expenses, receipts are required regardless of the amount. Rather than reimbursing employees for actual expenses, an accountable plan can instead pay predetermined mileage or per-diem travel allowances up to the amounts paid to federal employees. Companies that opt for this simplified method don't need their employees to substantiate actual expense amounts.

3. Return of Excess Payments: Within a reasonable period of time, employees must be required to return reimbursements or advances that exceed actual substantiated expenses. Under an exception, employees aren't required to return excess mileage or per-diem travel allowances based on the amounts allowed to federal employees.

4. Reasonable Time: Substantiation of expenses and the return of excess payments must occur within a reasonable period of time.

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In a 2009 private letter ruling, the IRS concluded that a company plan that reimbursed employees for the cost of providing their own job-related tools and equipment qualified as an accountable plan. The employer required that managers approve the expenditures and that the tools be kept on company premises and used exclusively for work performed for the company.

Other Reimbursement Arrangements

Unless your company's plan...