Accountable plans are an IRS-approved way to reimburse employees for various business expenses in a tax-advantaged manner. Everyone wins … employees are not taxed on reimbursements (the reimbursements not even reported on W-2s) and employers don’t pay employment taxes on the reimbursements.
Accountable plans have been around for a long time, but with changes in the Tax Cuts and Jobs Act, they are more important than ever. Here’s why you need to revisit accountable plans now … expand what you have or adopt one if you don’t … and how they work.
Why you need to revisit accountable plans
The Tax Cuts and Jobs Act made changes that may be favorable to your business but at the same time made one big unfavorable change for employees. The Act suspended for 2018 through 2025 the miscellaneous itemized deduction for unreimbursed employee business expenses. This deduction had allowed employees who itemized their deductions to write-off their work-related costs as a deduction to the extent they exceeded 2% of adjusted gross income (AGI). Examples of employee business expenses that fell within the 2%-of-AGI rule (and could have been deductible on employees’ 2017 returns) include:
- Car or truck expenses
- Education expenses
- Home office deduction (if the office is used for the convenience of the employer)
- Tools and equipment
- Work clothes and uniforms
- Union dues
So for 2018 through 2025, employees who pay for these business expenses out of their own pockets get no tax deduction. This limitation applies not only to rank-and-file employees but also to owners of C or S corporations who personally pay for corporate expenses because they are employees of their businesses.
But companies can help out employees by covering costs under an accountable plan. In an ever-tightening job market, this feature can be an important tool for recruiting and retaining employees.
How to make accountable plans work effectively
An accountable plan is a reimbursement arrangement that meets these 3 conditions:
- The expenses must have a business connection. This means they must have paid or incurred deductible expenses while performing services as an employee of the employer.
- The employee must adequately account to the employer for these expenses within a reasonable period of time. A reasonable period is 60 days after the expenses are paid or incurred. If an employer reimburses an employee’s driving using the IRS mileage rate (54.5 cents per mile in 2018), then costs need not be substantiated, but other elements of business driving (date, mileage, destination, etc.) must be reported to the employer using an expense account report, app, or other written record.
- The employee must return to the employer any excess reimbursement or allowance within a reasonable period of time. A reasonable period here is 120 days after the expenses are paid or incurred. If an employer gives an employee a certain amount each month to cover his or her expenses without regard to actual costs, this is simply additional compensation and not a reimbursement under an accountable plan.
If all 3 conditions aren’t met, the reimbursement arrangement is treated as a non-accountable plan. This means the reimbursements are taxable compensation to the employee and subject to employment taxes. You can’t opt to reimburse employees under an accountable plan for items that are not deductible by you; this reimbursement is treated as being under a non-accountable plan. For example, if you reimburse an employee for meals when working overtime, the portion of reimbursements covering this nondeductible expense is treated as being under a non-accountable plan.
If you want to adopt an accountable plan, there is no IRS form for this purpose. In fact, there’s technically no requirement to have the plan in writing, but you should do so. You can use a template, such as one from the Watson CPA Group, or create your own. And if you’re incorporated, it’s a good idea to reflect the adoption of the plan in your corporate minutes.
Until now accountable plans have been used primarily for travel and entertainment costs. However, their use isn’t restricted to these costs. You may want to have your plan cover an employee’s home office expenses (e.g., Internet access), tools and equipment, uniforms (beyond what the law requires an employer to pay for), and the costs of driving their personal vehicles on company business.
Because of the many issues that accountable plans entail, it’s a good idea to work with a benefits expert so you get things right!