A business expense reimbursement or allowance arrangement is a system by which a company pays advances, reimbursements, and charges for an employee’s business expenses. How your company reports a reimbursement or allowance amount depends on whether the company has an accountable or a non-accountable plan. According to the IRS, if a single payment includes both wages and an expense reimbursement, you must specify the amount of the reimbursement. The IRS Publication 15 (newly updated for 2017) contains the guidelines for handling both accountable and non-accountable plans. The rules apply to all ordinary and necessary employee business expenses that would otherwise qualify for a deduction by the employee.
To be an accountable plan, your reimbursement or allowance arrangement must require your employees to meet all three of the following rules.
- The employee must have paid or incurred deductible expenses while performing services as your employees. 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.
- The employee must substantiate these expenses to you within a reasonable period of time (120 days to return or account for it).
- The employee must return any amounts in excess of substantiated expenses within a reasonable period of time.
If expenses covered by this arrangement are not substantiated (or amounts in excess of substantiated expenses aren’t returned within a reasonable period of time), the amount paid under the arrangement in excess of the substantiated expenses is treated as paid under a non-accountable plan. This amount is subject to income, social security, Medicare, and FUTA taxes for the first payroll period following the end of the reasonable period of time.
Payments to your employee for travel and other necessary business expenses under a non-accountable plan are wages and are treated as supplemental wages and subject to income, social security, Medicare, and FUTA taxes. Your payments are treated as paid under a non-accountable plan if:
- Your employee isn’t required to or doesn’t substantiate timely those expenses to you with receipts or other documentation,
- You advance an amount to your employee for business expenses and your employee isn’t required to or doesn’t return timely any amount he or she doesn’t use for business expenses,
- You advance or pay an amount to your employee regardless of whether you reasonably expect the employee to have business expenses related to your business, or
- You pay an amount as a reimbursement you would have otherwise paid as wages.
Check here for additional guidance from the IRS on how to withhold taxes on supplemental wages (such as allowances paid under a non-accountable plan), which depends on whether the supplemental payment is identified as a separate payment from regular wages.
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