Accountable plan

What Is an Accountable Plan?

An accountable plan is an expense reimbursement arrangement established by an employer that allows for the tax-free reimbursement of ordinary and necessary business expenses incurred by employees. This financial arrangement, a critical component of tax law and payroll management, benefits both employees and employers by ensuring that reimbursements for work-related costs are not treated as taxable income to the employee and are deductible for the employer. To qualify as an accountable plan under Internal Revenue Service (IRS) regulations, specific criteria related to business connection, substantiation, and the return of excess funds must be met.

History and Origin

The concept of distinguishing between various types of employee expense reimbursements for tax purposes has evolved over time. The Internal Revenue Code (IRC) Section 62(c) and Treasury Regulation 1.62-2 specifically define the requirements for an accountable plan. These regulations were put in place to ensure that only legitimate business expenses are reimbursed tax-free, preventing abuse of the system. For instance, the rules outlined in 26 CFR § 1.62-2, "Reimbursements and other expense allowance arrangements," provide detailed guidelines on what constitutes a valid accountable plan, including provisions for business connection, substantiation, and the return of excess amounts.(⁹https://www.law.cornell.edu/cfr/text/26/1.62-2) This regulatory framework underpins how employers manage employee reimbursement programs today.

Key Takeaways

• An accountable plan allows employers to reimburse employees for legitimate business expenses without the reimbursement being considered taxable income to the employee.
• To qualify, expenses must have a business connection, be adequately substantiated with documentation, and any excess reimbursement must be returned within a reasonable timeframe.
• These plans offer tax advantages, reducing both the employee's gross income and the employer's payroll tax liability.
• Common expenses covered include travel, meals, car expenses, and supplies incurred for work purposes.
• Failure to meet the accountable plan rules results in reimbursements being treated as a nonaccountable plan, making the reimbursements taxable wages.

Interpreting the Accountable Plan

An accountable plan is a vital tool for managing employee expenses in a tax-efficient manner. Its interpretation hinges on adherence to three core IRS rules: business connection, substantiation, and the return of excess amounts. If an expense falls within the scope of an employee's job duties and directly benefits the employer's business, it generally has a business connection. Adequate recordkeeping, including receipts and detailed expense reports, is crucial for substantiation. The "reasonable period" for substantiation and return of excess funds typically means within 30-60 days, though specific timeframes can be defined by employer policy or safe harbor rules. Proper interpretation ensures that reimbursements are excluded from the employee's gross income, thereby avoiding unnecessary income tax and Social Security and Medicare taxes.

Hypothetical Example

Consider Sarah, a marketing specialist for Tech Solutions Inc. (TSI). She needs to travel to a conference in another city to represent the company and learn about new industry trends. Her expenses include airfare, hotel accommodation, and meals.

1. Expense Incurrence: Sarah pays for her flight ($400), hotel ($600 for two nights), and meals ($150) using her personal credit card.
2. Substantiation: Upon her return, Sarah gathers all her receipts. She prepares an expense report detailing the business purpose of the trip, the dates, locations, and the amounts spent. She attaches copies of her flight itinerary, hotel bill, and meal receipts.
3. Submission and Review: Within 10 days of returning, Sarah submits her expense report to TSI's accounting department. The department reviews the report to ensure all expenses have a clear business connection and are adequately documented according to the company's established accountable plan.
4. Reimbursement: Since all expenses are legitimate and properly substantiated, TSI reimburses Sarah the full $1,150 ($400 + $600 + $150). Because TSI operates an accountable plan, this $1,150 reimbursement is not included in Sarah's Form W-2 as taxable wages. Sarah receives the full amount, and TSI can deduct these expenses as legitimate business costs.

Practical Applications

Accountable plans are widely used across various industries for managing employee out-of-pocket expenses. They are particularly common for employees who frequently travel for business, such as sales representatives, consultants, and field service technicians. Employers utilize accountable plans to reimburse costs like:

• Travel Expenses: Airfare, lodging, and transportation related to business trips. IRS Publication 463 provides extensive details on deductible travel, gift, and car expenses.(⁸https://www.irs.gov/forms-pubs/about-publication-463-travel-gift-and-car-expenses)
• Meals: Business-related meals incurred while traveling away from home.
• Car Expenses: Mileage or actual expenses for using a personal vehicle for business, often reimbursed via a per diem or standard mileage rate.
• Supplies and Equipment: Costs for office supplies, tools, or other necessary equipment purchased by the employee for work.
• Home Office Expenses: Reimbursements for a portion of utilities, internet, or rent/mortgage for employees who maintain a home office for the employer's benefit, particularly for S Corporations and LLCs where owners are also employees.

These plans help businesses maintain compliance with tax regulations while providing a structured approach to expense management.

Limitations and Criticisms

While highly beneficial, accountable plans have specific limitations. The primary challenge for both employers and employees lies in strictly adhering to the substantiation rules. Any deviation, such as inadequate documentation or failure to return excess reimbursements promptly, can cause the entire arrangement to be reclassified as a nonaccountable plan. When this occurs, all reimbursed amounts become taxable to the employee and subject to withholding taxes.

Furthermore, the Tax Cuts and Jobs Act (TCJA) of 2017 suspended miscellaneous itemized deductions for tax years 2018 through 2025. This change significantly limited the ability of employees to deduct unreimbursed business expenses on their personal tax returns.(⁷https://www.aicpa-cima.com/news/article/reimbursing-expenses-through-an-accountable-plan) Consequently, an accountable plan becomes even more crucial for employees to receive tax-free reimbursements for their work-related expenditures. Employers must also be vigilant to prevent a "pattern of abuse" where excess amounts are consistently provided and not returned, as this can lead to the entire arrangement being treated as nonaccountable.(⁶https://www.irs.gov/pub/irs-drop/rr-05-52.pdf) The administrative burden of thorough auditing and compliance can also be a point of criticism, especially for smaller businesses.

Accountable Plan vs. Nonaccountable Plan

The fundamental difference between an accountable plan and a nonaccountable plan lies in the tax treatment of expense reimbursements for both the employer and the employee.

Confusion often arises because both plans involve employers reimbursing employees. However, the strict adherence to the IRS's three rules for an accountable plan determines whether the reimbursement is a tax-free event for the employee or a taxable addition to their compensation. If a reimbursement arrangement fails any of the accountable plan criteria, it automatically defaults to a nonaccountable plan.(⁵https://www.lawinsider.com/dictionary/accountable-expense-reimbursement-plan)

FAQs

What are the three requirements for an accountable plan?

An accountable plan must meet three specific IRS requirements: the expenses must have a business connection, they must be adequately substantiated (proven with documentation like receipts), and any amount reimbursed in excess of the substantiated expenses must be returned to the employer within a reasonable period.(⁴https://www.journalofaccountancy.com/issues/2020/feb/accountable-plan.html)

What types of expenses can be reimbursed under an accountable plan?

An accountable plan can reimburse ordinary and necessary business expenses that would otherwise be deductible by the company. Common examples include travel expenses (e.g., airfare, lodging), business meals, car expenses (e.g., mileage, fuel), office supplies, professional development costs, and client entertainment (subject to specific IRS limits).(³https://www.bench.co/blog/tax-tips/irs-accountable-plan)

Are accountable plan reimbursements reported on an employee's W-2?

No, qualified reimbursements made under an accountable plan are not considered wages and are therefore not reported on an employee's Form W-2. This is a key benefit, as it reduces the employee's gross income for tax purposes.(²https://www.fylehq.com/blog/accountable-plan)

What happens if an accountable plan's rules are not followed?

If an employer's expense reimbursement arrangement does not meet all the requirements of an accountable plan, it is treated as a nonaccountable plan. In this scenario, all reimbursements are considered taxable wages to the employee and must be reported on their Form W-2, subject to income tax and payroll tax withholding.(¹https://www.law.cornell.edu/cfr/text/26/31.3401%28a%29-4)

What is considered a "reasonable period" for substantiation or return of excess amounts?

The IRS defines a "reasonable period" through safe harbor rules. Generally, this means that an expense advance should be made within 30 days of the expense, expenses should be substantiated within 60 days after they are paid or incurred, and any excess amounts should be returned within 120 days of the expense. However, employers can set their own reasonable timeframes within these guidelines.