An accountable plan is an arrangement between employers and employees where the company reimburses employees for specified business expenses. If done right, the plan is a win-win because the reimbursements aren’t taxable to employees and the employers don’t pay employment taxes on the reimbursements even though they’re tax deductible. Accountable plans were discussed in a previous blog to help employees who cannot deduct their business expenses in 2018 through 2025, but with the pandemic there’s increased focus on their use.
Accountable plan basics
Typically, accountable plans have been used to reimburse employees for business meals and travel expenses. However, there is nothing in IRS rules restricting reimbursements to these expenses. Today, in the era of the pandemic, businesses are paying for more employees’ costs, such as internet access, cell phones, and other employee costs for working remotely and personal protective equipment (PPE) to keep them safe from contracting or spreading COVID-19. OSHA requires employers to pay for PPE, but this can be handled by employees buying their own items and getting reimbursed for their costs. For the reimbursements of any kind to viewed as being under an accountable plan, three conditions must be met:
- Business connection. There must be a business connection for the employees’ expenses.
- Adequate accounting. Employees must account to the employer for expenses within a reasonable period of time (within 60 days of when the expenses are paid or incurred).
- Refunding excess reimbursements. Employees who are advanced funds to cover expenses must return to the employer excess amounts (i.e., amounts not expenses on reimbursable items) within a reasonable period of time (120 days after expenses are paid or incurred).
Make it formal
There are no IRS forms to complete to make an accountable plan official. But be sure to put the plan adoption in writing. Intuit has a sample form that can be used to adopt an accountable plan.
The law doesn’t cap the dollar amount of reimbursements. It’s up to you to set parameters for your reimbursement plan—what you will or will not cover and any dollar limits that apply.
Avoid expense accounts without limits
If the IRS finds that the accountable plan fails to meet the three conditions, reimbursements become taxable compensation to employees and are subject to employment taxes. Here are two examples of what NOT to do:
Example 1: A company required their service technicians to have their own tools (e.g., wrenches, power tools). It created a plan to help employees pay for their tools. They gave each employee a specified amount annually, which was a “tool benefit” based on a formula determined by the hours employees worked. However, the plan was not an accountable plan because it didn’t require employees to show the tools were used only for the employer with the plan or to substantiate that the allowances were used to buy tools. Bottom line: the plan did not make reimbursements; it merely characterized additional pay as such in an attempt to create nontaxable compensation.
Example 2: Another company devised its own tool reimbursement arrangement. But employees received amounts regardless of whether expenses were paid or incurred or reasonably expected to be paid or incurred by them in the performance of services for the employer. Again, the plan was not an accountable plan.
Keep good records
As with any business expenses, for the employer to be able to deduct costs, there must be good records. Requiring employees to turn in their receipts for items covered by the plan is essential in case the IRS questions the employer’s return.
Reimbursement arrangements for partners and LLC members
Because partners and LLC members aren’t employees, they aren’t covered by accountable plans. But the business can reimburse them for business-related expenses. If the partnership/LLC requires owners to pay expenses personally (i.e., there is no right to reimbursement), then these owners can deduct their unreimbursed partnership expenses on their personal returns.
Discuss reimbursement arrangements with your CPA or other tax advisor to make sure you’re handling things right. While the savings for operating a plan correctly can be great, the cost of mistakes can be even greater.