Accountable Plan for S Corporations / LLC's question: I'm looking to consult with someone with allot of experience putting these in place for S Corporations and LLC's. Someone who feels that they have expert level knowledge in this area.
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Business Expenses: Accountable vs. Non-Accountable Expense Reimbursement
Employees frequently incur expenses in the course of their employment. Some of these may be reimbursed by the employer, while others may be the expense of the employee. The type of reimbursement plan administered by the employer is important for the employee, as it can have a significant impact on the employee’s tax liability. A business may have either an accountable or a non-accountable plan. If the reimbursement plan does not meet all criteria for an accountable plan, it will be a non-accountable plan.
An accountable plan has three features that must be included:
1. The expenses must have a business connection. They must be incurred while performing services for the employer or on behalf of the employer.
2. The employee must adequately account to the employer for the expenses within a reasonable period of time.
3. The employee must return any excess reimbursement within a reasonable period of time.
These features need explanation to assure that the plan meets the stated requirements. First, they are expenses that are incurred in the course of one’s employment. Personal expenses are not deductible (or reimbursable) business expenses. Personal expenses are expenses incurred for personal, living or family expenses. If an expense is partially business and partially personal, it must be allocated between the two. A common example is a personal vehicle that is also used for business purposes. The business use of the vehicle is a deductible (or reimbursable) expense.
Second, the employee must make an adequate accounting within a reasonable period of time. “What constitutes an adequate accounting?” The employee must show that he or she spent the money for a legitimate business reason. Third-party evidence, such as a receipt will normally suffice. If not evident on the face of the document, the employee should record business purpose, reason for the expenditure, the date, location, and other parties involved (such as when providing meals or entertainment).
There are four exceptions to the rule that documentation must be provided. Individual outlays for expenses other than lodging for less than $75 do not require a receipt. Secondly, if the employer is reimbursing for meals or lodging using the IRS per diem amounts, no receipt is required. It should be noted that a company may reimburse an employee at the GSA per diem amounts for lodging, but the employee may not use the per diem for deducting unreimbursed lodging. Third, due to the difficulty of obtaining a receipt for transportation such a taxi, subway or bus, the IRS is more lenient in requiring a receipt. However, a log book of expenditures should be maintained.
The fourth exception is for mileage. Obviously, there is no receipt for mileage when driving a vehicle. To justify reimbursement, the employee should maintain a contemporaneous log indicating the destination, purpose, date of travel, persons visited and the number of miles traveled. Beginning and ending odometer readings, are mentioned by the IRS, but few keep such detail. Reimbursement may not exceed the IRS rate for business travel. Parking and tolls additional deductions, as they are not included in the standard mileage rate.
What is reasonable period of time? The IRS states that it is a facts and circumstances situation. However, they have guidelines that specify what constitutes a reasonable period of time. If the employee has received an advance it must be given within 30 days of the travel date. The expense must be substantiated within 60 days after the expense is paid.
The third element requires return of any excess reimbursement within 120 days of receipt of a statement from the employer that indicates outstanding advances.
These are IRS guidelines and a company is free to implement more restrictive rules. For example, the company may require substantiation for expenditures over $25, rather than the IRS $75 limit. Likewise, the company may pay for mileage at a rate less than the IRS standard rate. Reimbursements under an accountable plan are not taxable income to the employee and are not shown on the employee’s 1040. Non-reimbursed expenses may be deducted by the employee.
The alternative to an accountable plan is an allowance or non-accountable plan. By definition, a non-accountable plan is one that does not meet the requirements of an accountable plan. Routinely these plans involve the employer providing a set amount (or allowance) to the employee for travel. The employee does not account to the employer for the expenditure of these funds. The allowance amount is taxable income and should be included on the employee’s W-2. The employee may deduct the expenses incurred as miscellaneous itemized deductions on Schedule A. These are subject to the two-percent limitation, so the employee can only deduct expenses that exceed two percent of his or her adjusted gross income. The employee must itemize deductions to get a tax benefit. This type of arrangement can be detrimental to the employee from a financial perspective, but requires less recordkeeping for the employer.
Ordinary and Necessary
Whether an expense is reimbursed by the employer or if it falls on the employee, the same IRS guidelines apply. An expense must be “ordinary” and “necessary” under IRS rules.
The terms “ordinary” and “necessary” carry specific meanings for tax purposes, and the common use of these words is not applicable here. Ordinary expenses are expenses that are commonly used and accepted by general industry standards. That is, things that are typically needed to run your business. An expense is necessary if it is helpful and appropriate in running the business. Focus on the word “helpful.” The expense does not need to be required in order to properly conduct one’s occupation or business. What is ordinary and necessary also depends on the individual situation. It may be ordinary and necessary to entertain clients at an expensive restaurant and provide limousine service in negotiating a multi-million dollar contract. By contrast, doing the same for a customer who purchases $500 annually would not be considered ordinary and necessary. An expense must be both ordinary and necessary to be deductible or reimbursable. The IRS also has the right to apply a “lavish” criteria to business expenses and may disallow any expenses that it deems to be lavish or extravagant. This is normally applied only in extreme circumstances.
It is important from an IRS perspective, as well as from an ethical view, that all employee reimbursements be properly and equitably handled. This is an area that can easily be abused. Setting and following policies for these expenditures is a necessity to allow a business to be financially accountable and avoid IRS inquiries.
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