Understanding Tax Issues of Employee Expense Reimbursement Plans

Employers will generally reimburse or provide advances to cover ordinary and necessary business expenses incurred by their employees for travel, meals, and entertainment.  Specific tax rules, including time limits, must be observed to avoid income tax pitfalls.  There are two tax categories of expense reimbursement plans:  accountable (tax favorable) and nonaccountable (tax unfavorable).

For an accountable plan, the employee must timely document the expenses to the employer and also timely return any excess reimbursement or advance to the employer.  The time requirements are as follows:

1. The employer may not provide an advance more than 30 days before the time the employee will incur the expense.
2. The employee must provide adequate documentation of expenses within 60 days after the expense was paid or incurred.
3. The employee must return any excess reimbursement within 120 days after the expense was paid or incurred.
4. If the employer gives periodic statements (at least quarterly) to the employee asking for an accounting of the expenses and a return of any excess reimbursement, then employee must comply within 120 days of the date of the statement.

The tax benefit of an accountable plan is that the expense reimbursement is not treated as taxable wages.

In lieu of actual expenses, per diem amounts for lodging and meals and incidental expenses, and mileage rates for driving a personal car for business may be used.  As long as the amounts do not exceed the rates published by the IRS, and the employee otherwise provides documentation, the employee is deemed to have met the accountable plan rules and any excess does not need to be returned to the employer.  See IRS Publication 1542 for per diems rates.  The business mileage rate for 2012 is 55.5 cents per mile.

A nonaccountable plan is an arrangement that does not meet the rules for an accountable plan.  Also, if the employee does not comply with the time requirements, then the expense reimbursements are treated as though paid under a nonaccountable plan.  The amounts paid under a nonaccountable plan are treated as regular taxable wages, subject to income and payroll tax withholdings, and are reported on Form W-2.  The employee may then deduct the business expenses, but they are miscellaneous itemized deductions.  Miscellaneous itemized deductions only provide tax savings to the extent the total exceeds 2% of adjusted gross income, if the employee has itemized deductions in excess of the standard deduction, and if the employee is not subject to the alternative minimum tax!  There are a lot of hurdles for an employee to clear to receive a tax deduction for business deductions under a nonaccountable plan, so it is advisable for the employee to comply with the accountable plan rules to avoid very negative tax results.