Accountable Expense Reimbursement Plans
September 28, 2018
At this point, most, if not all, professional tax and business advisors appear to be aware of the change in treatment for miscellaneous deductions ushered in by the 2017 Tax Cuts & Jobs Act (“TCJA”). However, based upon a number of conversations I have had with both practitioners and clients during 2017, sensitivity concerning a trap that can result in double taxation appears to be relatively low.
Prior to 2018, when an employee incurred work related expenses and was reimbursed by her employer, the employer was allowed to deduct the amount of the reimbursement as an ordinary and necessary business expense, the employee was required to report the amount of the reimbursement payment as income, and the employee was allowed to deduct the expense as a miscellaneous expense. Effective January 1, 2018 this is no longer the case.
Under the provisions of TCJA, suspension of the miscellaneous expense deduction effectively eliminates an employee’s ability to deduct work related expenses, while retaining the requirement that she include the reimbursement in income. Consider the effect: taxable income earned by an employee is used by the employee to pay for work related items; the amount received by the employee from her employer as a reimbursement payment for the work related expense incurred by the employee is also included in the employee’s taxable income. Double inclusion, double taxation.
My expectation is that this will likely be a very fruitful area for the IRS’ auditors in the near future. Consider the example of a business owner who periodically pays for materials, supplies, transportation costs, or meals and entertainment using personal funds or personal credit who is later reimbursed by his business, I believe we would agree that this example represents an actual reimbursement that should be reported on the business owner’s W-2 for the year not realizing that she is no longer entitled to deduct these expenses.
A second example, which unfortunately occurs more often than it should, involves a situation where a sole proprietor has decided to conduct her business through a legal entity, but fails to transfer one or more supplier accounts from the sole proprietorship to the legal entity. Over the course of time, the legal entity simply makes direct payments to the supplier notwithstanding the fact that the account remains under the name of the owner - employee. Re-classification of the payments made by the entity to the supplier as a constructive reimbursement payment made to the owner – employee should not be unexpected.
Fortunately, the Internal Revenue Service has provided a solution for this problem in the form of written Accountable Expense Reimbursement Plans that have been formally adopted by the employer. If an employer has adopted a written policy or plan that addresses employee reimbursements for work related expenses, amounts paid by an employer to an employee for work related expenses are deductible by the employer and excluded from the employee’s income. Whether reimbursements received by an employee are deductible is no further concern.
As you might expect, the Internal Revenue Service has issued regulations that set forth the minimum requirements that must be addressed by an Accountable Expense Reimbursement Plans for the plan to qualify for the tax treatment referenced above.
NOTE: If the adopted plan fails to meet all of the requirements set forth in the regulations or if the plan is not administered consistently, the benefits enjoyed by the employee under the plan (exemption of reimbursements from employee income) will be lost.
Currently, we are recommending that employers who had not adopted an Accountable Expense Reimbursement Plan before or during 2017, adopt a qualified plan before December 31, 2018. If you have questions concerning Accountable Expense Reimbursement Plans or have clients who may be interested in adopting a qualified Accountable Expense Reimbursement Plan, please send me an email at firstname.lastname@example.org or call me at 360-326-8010.