As a business owner, it’s possible that your employees are regularly incurring expenses on the job for things like lodging, booking flights, or taking clients out for lunch. Unless your employees are using company cards, you’ll need to pay them back.
There are two main ways you can reimburse your employees:
- An Accountable Reimbursement Plan
- A Non-Accountable Reimbursement Plan
These two options each have different implications come tax season. The main difference between an accountable and a non-accountable plan is how reimbursements are treated for tax purposes.
What you need to know for now is that an accountable reimbursement plan can provide significant tax savings for both you and your employees, especially if you have a large sales or service force.
1) The Accountable Reimbursement Plan
Under an accountable plan, employee reimbursements are not reported as income. As a result, employees have less taxable income and employers avoid payroll taxes and W-2 reporting.
So if an accountable plan can save you money, why doesn’t everyone use one?
In short, it’s more time consuming. Employers and employees must abide by several requirements in order for a company to qualify for an accountable plan:
Requirements of Employers:
- You must reimburse your employees within 30 days of them incurring the expense
Requirements of Employees:
- Employees must substantiate their expenses within 60 days of incurring the expense through receipts, invoices, or other documentation
- Employees must return any excess reimbursements within 120 days of incurring the expense
- The employee’s reimbursed activities must have a direct connection to the business and job responsibilities
Advantages of an accountable plan:
- Tax savings for businesses and employees
- Employees can exclude reimbursement amounts from their taxable income
- Employers avoid payroll taxes and W-2 reporting
- Simple solutions, like Fetch, exist to automate expense tracking
Disadvantages of an accountable plan:
- More time intensive
- Requires extensive record-keeping
2) The Non-Accountable Reimbursement Plan
If a reimbursement plan does not meet all criteria for an accountable plan, it is considered a “Non-Accountable Plan” by the IRS. Under a non-accountable plan, the amount reimbursed to the employee IS reported as income.
Most companies operating under a non-accountable plan provide their employees with set allowances to use during business-related travel. Employees uses their allowances to pay for business expenses and can keep the leftover amounts. Employees also don’t need to provide any expense documentation to the employer.
Sounds like a lot less work right? While this process is less time-consuming, it can also be quite costly monetarily. To illustrate, let’s look at a real-life scenario:
Suppose a company is operating on a non-accountable plan, and provides its sales team members, who often travel, with $6000 annual ($500 monthly) automobile allowances. The non-accountable plan reports the automobile allowances as income. Thus, the employer incurs nearly $450 in payroll taxes, and the employees incur nearly $2500 in additional income taxes.
This cumulative ~$3000 in additional tax costs could have been otherwise avoided under an accountable plan.
Advantages of a Non-Accountable Plan:
- Less record keeping required
Disadvantages of a Non-Accountable Plan:
- Lose out on tax savings
How Does a Business Declare an Accountable Reimbursement Plan?
The IRS does not require any type of form submission to declare an accountable plan. A company simply must abide by the accountable plan requirements and be able to provide documentation proving their following of the practices.
The IRS recommends that the requirements of the accountable plan be put in writing for employees, for example as part of the employee policy & procedures manual.
In summary, using an accountable plan provides can provide tax benefits for you and your and employees, especially if you’re managing a large sales or service force. An accountable plan requires diligence and attention to detail, but many tools like Fetch exist to make expense tracking and reimbursement management simple.