Non accountable reimbursement

What Is Non Accountable Reimbursement?

Non accountable reimbursement refers to an arrangement where an employer provides funds to an employee for expenses incurred, but the employee is not required to provide substantiation for how the money was spent or return any excess funds. In the realm of employee compensation and taxation, non accountable reimbursement is generally treated as taxable income to the employee, unlike reimbursements made under an "accountable plan" that meet specific Internal Revenue Service (IRS) criteria. These arrangements fall under the broader financial category of fringe benefits. When an employer provides non accountable reimbursement, the amount is included in the employee's gross wages and is subject to applicable income tax withholding, Social Security, and Medicare taxes, much like regular salary or wages.

History and Origin

The distinction between taxable and non-taxable employee reimbursements has evolved as part of U.S. tax code development, particularly with the establishment of rules governing business expenses. The Internal Revenue Service (IRS) continually refines its guidance on what constitutes a legitimate, non-taxable business expense reimbursement versus what should be considered additional compensation. This framework is largely defined by regulations that differentiate between "accountable plans" and "non-accountable plans." The Tax Reform Act of 1986 significantly impacted how employee business expenses were treated, setting the stage for the current detailed regulations on expense reimbursement. Prior to this, employees had more leeway in deducting unreimbursed employee expenses. Today, detailed guidance on the taxability of various fringe benefits and reimbursements is published annually by the IRS in documents such as Publication 15-B, Employer's Tax Guide to Fringe Benefits.¹³

Key Takeaways

• Non accountable reimbursement is a payment from an employer to an employee for expenses without requiring substantiation or the return of excess funds.
• Amounts paid as non accountable reimbursement are considered taxable income to the employee and are subject to payroll taxes.
• Employers must report non accountable reimbursements on an employee's Form W-2.
• This type of reimbursement contrasts sharply with an accountable plan, which allows for tax-free reimbursement of legitimate business expenses.
• The IRS provides specific criteria that a reimbursement arrangement must meet to qualify as an accountable plan.

Interpreting the Non Accountable Reimbursement

When an employer uses a non accountable reimbursement arrangement, it signifies that the funds provided for expenses are not treated as direct repayments for specific, substantiated business costs. Instead, they are viewed as part of the employee's total gross income. This means the amount adds to the employee's overall tax liability and is subject to the same withholding tax requirements as their regular salary. For employees, it is crucial to understand that such reimbursements increase their taxable earnings, impacting their take-home pay and potentially their overall tax burden at year-end. Employers must ensure accurate reporting on payroll and W-2 forms to maintain compliance with tax regulations.

Hypothetical Example

Sarah works for TechSolutions, a company that provides its employees with a flat $200 per month for general "home office expenses" without requiring any receipts or documentation. This $200 is paid out regardless of whether Sarah actually incurs $200 in expenses or not.

In this scenario, the $200 monthly payment is considered a non accountable reimbursement. It is added to Sarah's regular wages, and taxes (federal income tax, Social Security, and Medicare) are withheld from the total amount. If Sarah's regular monthly salary is $4,000, her taxable gross pay for the month will be $4,200 ($4,000 salary + $200 non accountable reimbursement). TechSolutions includes this $200 on Sarah's W-2 form at the end of the year as part of her wages. Sarah cannot deduct any actual home office expenses she might have incurred that month because the reimbursement she received was non-accountable and already taxed as income.

Practical Applications

Non accountable reimbursement arrangements appear in various business contexts, though they are generally less advantageous from a tax perspective than accountable plans. They might be used in situations where:

• Fixed Allowances: An employer might provide a fixed monthly allowance for certain expenses (e.g., cell phone usage, car allowance) without requiring detailed recordkeeping or reconciliation. Since substantiation is not required, these allowances are typically treated as non accountable.
• Per Diems Without Accountability: While per diem allowances can be part of an accountable plan if specific IRS rules are met (e.g., related to travel, within IRS limits), if a per diem is provided without any requirement to substantiate travel or return excess, it becomes non-accountable.
• Failure to Meet Accountable Plan Rules: If an employer's reimbursement plan fails to meet even one of the three IRS criteria for an accountable plan (business connection, substantiation, or return of excess), all reimbursements made under that plan automatically default to a non accountable status. This means they are considered taxable income to the employee.¹² The Internal Revenue Service (IRS) outlines these guidelines in detail to ensure proper tax treatment of such payments.¹¹ Employers must correctly report these amounts through their payroll systems.¹⁰

Limitations and Criticisms

The primary limitation and criticism of non accountable reimbursement stems from its tax implications. For employees, receiving non accountable reimbursement means that these funds are added to their taxable wages, reducing their net take-home pay and increasing their personal tax liability. Unlike deductible expenses reimbursed under an accountable plan, employees generally cannot deduct the actual expenses incurred if they receive a non accountable reimbursement, especially since the Tax Cuts and Jobs Act (TCJA) of 2017 suspended miscellaneous itemized deductions for most employees until 2026.⁹

For employers, while a non accountable plan might seem simpler due to less recordkeeping burden, it results in higher payroll tax obligations because the reimbursed amounts are subject to FICA (Social Security and Medicare) and FUTA (Federal Unemployment Tax Act) taxes.⁸ Additionally, a consistent pattern of failing to meet accountable plan rules can draw scrutiny from the IRS, potentially leading to audits and penalties for non-compliance.⁷ Critics argue that such arrangements can create a less transparent compensation structure and may not incentivize employees to be prudent with spending, as the funds are provided irrespective of actual expenditures.

Non Accountable Reimbursement vs. Accountable Plan

The core distinction between non accountable reimbursement and an accountable plan lies in their tax treatment and the IRS requirements they satisfy.

In essence, an accountable plan offers significant tax advantages for both employers and employees by allowing reimbursements for legitimate business expenses to be tax-free. Non accountable reimbursement, by contrast, treats such payments as additional compensation subject to full taxation, similar to regular wages. Companies typically prefer establishing an accountable plan to optimize their financial planning and minimize tax burdens for both parties.

FAQs

Q1: Is non accountable reimbursement always taxed?

Yes, non accountable reimbursement is always considered taxable income to the employee. This means the amount is included in the employee's gross wages and is subject to federal income tax, Social Security, and Medicare taxes, as well as any applicable state and local taxes.³

Q2: How does an employer report non accountable reimbursement?

Employers report non accountable reimbursement as part of the employee's regular wages on their Form W-2, Box 1 (Wages, Tips, Other Compensation). Since it's considered wages, it is also subject to federal income tax withholding, Social Security tax, and Medicare tax.

Q3: Why would an employer use a non accountable reimbursement plan?

While less tax-efficient, some employers might opt for a non accountable reimbursement arrangement for its simplicity. It requires less recordkeeping and administrative oversight compared to an accountable plan, as there's no need to review receipts or track the return of excess funds. However, the trade-off is the increased tax burden for both the employee and the employer.

Q4: Can an employee deduct expenses if they receive non accountable reimbursement?

Generally, no. If an employee receives a non accountable reimbursement, they cannot also deduct those expenses on their personal tax return. The reimbursed amount has already been taxed as income. Furthermore, due to changes from the Tax Cuts and Jobs Act of 2017, most unreimbursed employee business expenses are no longer deductible for federal income tax purposes for individuals through 2025, regardless of whether a reimbursement plan is in place. This underscores the importance of a properly structured accountable plan for tax-free expense repayment.²

Q5: What are the risks of an employer failing to meet accountable plan rules?

If an employer's reimbursement plan fails to meet the IRS's criteria for an accountable plan, all amounts paid under that arrangement are automatically reclassified as non accountable reimbursement. This results in the amounts being treated as taxable wages, subjecting both the employer to additional payroll taxes and the employee to increased personal income tax. The IRS can assess penalties for underreported income or unpaid payroll taxes if an employer misclassifies reimbursements.¹