This letter explains the tax consequences of an employee reimbursement either under an employer’s accountable plan or nonaccountable plan.
In general, employee expenses reimbursed under an employer’s accountable plan are not considered income to the employee for federal income tax purposes. In contrast, employee expenses reimbursed under a nonaccountable plan are considered income to the employee and are subject to withholding.
An accountable plan is a reimbursement or other expense allowance arrangement that satisfies three basic requirements: a business connection; substantiation; and return of excess amounts. The requirements of an accountable plan are applied on an employee-by-employee basis.
To satisfy the business connection component, the business expenses covered by the plan: (1) must satisfy the requirements for deduction as business expenses; and (2) must be paid or incurred by the employee in connection with the performance of services as an employee. Allowances under the plan may include per diem allowances, allowances for meals and incidental expenses, and mileage allowances.
To satisfy the substantiation component, an accountable plan must require employees to furnish adequate substantiation of reimbursed expenses to the employer or other payor. The specific type of substantiation required under an accountable plan depends on the nature of the reimbursed expense, but in any case must be done in a reasonable amount of time. Certain types of expenditures are covered by other special rules. Such expenditures include: (1) traveling expenses, including meals and lodging while away from home; (2) any item with respect to an activity that is of a type generally considered to constitute entertainment, amusement, or recreation, or with respect to a facility used in connection with such an activity; (3) gifts; and (4) expenses with respect to any “listed property.” Other than the aforementioned expenses, substantiation is adequate if the information furnished to the employer is sufficient to identify the specific nature of each expense and to show that the expense is attributable to the employer’s business activities.
To satisfy the return of excess amounts component, the arrangement must require an employee to return to the employer within a reasonable period of time any amount that exceeds the employee’s properly substantiated expenses. If the arrangement contains the requisite provision for return of excess amounts, but an employee fails to return amounts received in excess of substantiated expenses within a reasonable period, the amounts paid to the employee that exceed the properly substantiated expenses are treated as paid from a nonaccountable plan. Special rules apply when an arrangement provides per diem allowances for ordinary and necessary business expenses of traveling away from home (excluding transportation costs to and from the destination) or mileage allowances for ordinary and necessary expenses of local transportation or travel away from home.
An arrangement between an employer and employee for advances, allowances, or reimbursement of business expenses that does not satisfy one or more of the three basic requirements of an accountable plan is treated as a nonaccountable plan
For tax purposes, amounts treated as paid under an accountable plan are excluded from the employee’s gross income, are not reported as wages or other compensation on the employee’s Form W-2, and are exempt from the withholding and payment of employment taxes (Federal Insurance Contributions Act (“FICA”), Federal Unemployment Tax Act (“FUTA”), Railroad Retirement Tax Act (“RRTA”), and Railroad Unemployment Repayment Tax (“RURT”)), and income tax. They are instead deductible as business expenses by the employer, subject to any limitations on the deduction of the particular type of expense. Note that there are exceptions to this rule for expenses that are either more or less than the reimbursed amounts.
When an employee’s expenses are allowed or reimbursed under a nonaccountable plan, the employer must report the amounts paid under the plan as wages on the employee’s W-2 Form. Moreover, such amounts are subject to withholding and to the payment of employment taxes, such as FICA, FUTA, RRTA, and RURT. Amounts paid under a nonaccountable plan are included in the employee’s gross income. Expenses attributable to amounts included in gross income are deductible by the employee, subject to all applicable limitations.