Reimbursing Your Employees the Right Way:
Using an accountable plan to reimburse employees for business expenses they paid for using personal funds.
An accountable plan is the vehicle the IRS allows for employees to be reimbursed for business expenses that are paid for personally. There are four requirements in an accountable plan: business connection, adequate substantiation, return of excess advances and reasonable time period.
An accountable plan is essentially just the IRS’s name for an employee expense reimbursement plan. It allows corporations to reimburse their employees without the employee being taxed for the reimbursement as if it were part of their gross income. Accountable reimbursements are good for both employees and employers because employees don’t have to pay taxes on the reimbursement and the reimbursement still counts as a deductible business expense for the employer.
For a reimbursement of an expense to be considered “accountable” it must meet four requirements:
Business Connection: Essentially, only expenses that benefit the business in some way can be considered eligible under the accountable plan rules. The IRS Fringe Benefit Guide states simply that “Business connection means that the employee must have paid or incurred allowable business expenses while performing services as an employee. The reimbursement or advance must be payment for the expenses and must not be an amount that would have otherwise been paid to the employee as wages. If you want to reimburse your employee for something that is hard to justify as beneficial to your business it may be better to offer a fixed dollar reimbursement that is classified as a fringe benefit rather than an accountable reimbursement. For example, if you pay for your employee’s cellphone and plan that they also use as their personal phone, this will not qualify under an accountable plan. Things such as spouse and family travel to business conferences will not count as accountable unless there is a clear business purpose for them to attend with your employee.
Substantiation: Employers need to be able to substantiate (prove) and provide adequate accounting that shows that their employees did in fact spend money for a business purpose. You should require your employees to document the date, time, place, and business purpose of the expense. They also should document and prove the amount spent. In most cases a receipt or some other evidence is required to verify. The IRS does not require receipts for a few things such as transportation expenses when a receipt is not readily available and in a few select other circumstances, but it is easier to maintain and enforce a company policy by being consistent – we recommend always requiring receipts. If you are paying a per diem for travel expenses, you don’t need to collect receipts, but the business connection for travel and where the travel occurred should still be formally substantiated.
Excess Advances are Returned: If you give your employees advances for business expenses rather than a reimbursement in order to reduce cash flow strain on your employees personal finances, you must require them to return any excess that was not used for expenses with a business connection. Any unreturned excess is subject to regular income taxes. If you are giving per diems to your employees for business travel rather than reimbursements, they need not return the excess. Visit the U.S. GSA website to find the current years per diem and maximum meals and incidental expenses (M&IE) rates for specific states and counties. If an employee is a more than 10% owner of a company, they cannot be paid per diems.
Timeliness: Reimbursements should be substantiated, and excesses should be returned all within a reasonable time period. Your accountable plan should require substantiation no later than 60 days after they are incurred and excesses for advances should be returned by employees no later than 120 days. However, it is much easier to just require that reimbursement requests and substantiation requests be submitted monthly.
Your accountable plan should be in writing and included in your company policy, not only to allow for easy proof to the IRS that you have one, but also so your employees are aware of what is required of them. You should include a list of any expenses that you will not reimburse.
Download a sample accountable plan below.