What Is a Nonaccountable Plan?
A nonaccountable plan is an arrangement under which an employer provides payments or allowances to an employee for expenses, but the arrangement does not meet specific Internal Revenue Service (IRS) requirements for tax-free expense reimbursement. In the realm of tax law and employment compensation, reimbursements made through a nonaccountable plan are considered additional wages to the employee, subject to federal income tax withholding and employment taxes. This means the payments are included in the employee's gross income and reported on their Form W-2. The key distinction of a nonaccountable plan is its failure to require proper substantiation of expenses or the return of any excess funds advanced to the employee.
History and Origin
The distinction between accountable and nonaccountable plans is rooted in U.S. federal tax regulations, specifically Treasury Regulation 1.62-2, which provides detailed guidance on employer expense reimbursement arrangements. The IRS established these rules to differentiate between legitimate business expense reimbursements, which should not be considered employee income, and disguised compensation, which should be taxed accordingly. Before these regulations, there was more ambiguity regarding how employers handled expense payments and how employees reported them.
A significant shift impacting the relevance of nonaccountable plans occurred with the passage of the Tax Cuts and Jobs Act (TCJA) in 2017. Prior to the TCJA, employees could potentially deduct unreimbursed business expenses as miscellaneous itemized deductions on Schedule A of their tax returns, subject to a 2% of adjusted gross income limitation. However, the TCJA suspended this deduction for tax years 2018 through 2025, making the distinction between accountable and nonaccountable plans even more critical for employees. If an employer's plan is a nonaccountable plan, the employee generally cannot deduct those reimbursed expenses on their personal tax return, making the entire reimbursement fully taxable32, 33.
Key Takeaways
- A nonaccountable plan treats expense reimbursements as additional taxable wages to the employee.
- Payments from a nonaccountable plan are subject to income tax withholding, Social Security taxes, and Medicare taxes.
- These reimbursements are reported on the employee's Form W-2, increasing their taxable income.
- Nonaccountable plans lack the IRS-mandated requirements for expense substantiation or the return of excess funds.
- Employees generally cannot deduct expenses reimbursed under a nonaccountable plan on their personal tax returns.
Interpreting the Nonaccountable Plan
When an employer operates a nonaccountable plan, it directly impacts the employee's tax obligations. Any payments or allowances received under such a plan are indistinguishable from regular wages for tax purposes. This means that if an employee receives a $500 allowance for business travel through a nonaccountable plan, that $500 is added to their gross pay, and taxes are withheld as if it were part of their salary.
The fundamental interpretation is that the IRS views these payments not as legitimate expense reimbursements but as compensation. Therefore, the burden of proof for any actual deductible business expenses incurred shifts entirely to the employee, who, due to changes in tax law, typically cannot deduct these unreimbursed expenses anyway. Employers must understand that failing to adhere to accountable plan rules results in higher payroll tax liabilities for both the employer and employee, and increased taxable income for the employee.
Hypothetical Example
Consider Sarah, a marketing consultant, whose employer provides her with a monthly car allowance of $400 for business-related travel. Her employer does not require her to submit mileage logs, gas receipts, or any other documentation to account for how she spends this $400. Furthermore, if she spends less than $400 on car-related expenses in a given month, she is not required to return the difference.
In this scenario, the employer's arrangement is a nonaccountable plan. Each month, the $400 car allowance is added to Sarah's regular wages. Federal income tax, Social Security, and Medicare taxes are withheld from the total amount, and the full $400 is reported as part of her taxable wages on her annual Form W-2. Even if Sarah diligently tracks her actual business mileage and finds she only spent $250 on legitimate business-related car expenses, she cannot deduct the $250 on her personal tax return. The entire $400 allowance remains fully taxable.
Practical Applications
Nonaccountable plans primarily manifest in situations where employers provide employees with fixed allowances or stipends for expenses without requiring adequate documentation or the return of unspent funds. Common examples include:
- Flat Car Allowances: As in the hypothetical example, a company might pay a fixed monthly amount for vehicle use without requiring mileage logs or expense reports.
- Per Diem Allowances Not Properly Substantiated: While per diem arrangements can be part of an accountable plan if they meet specific IRS rules for deemed substantiation, an employer paying a flat per diem without requiring any travel or ensuring it aligns with IRS rates could inadvertently create a nonaccountable plan. For example, if a company pays a daily rate for meals and lodging but does not require the employee to travel away from home or fails to apply reasonable business practices, the payments may become taxable30, 31.
- General "Miscellaneous" Expense Allowances: Providing a fixed amount for various business costs without any mechanism for accountability.
- Educational Reimbursements Not Tied to Work: While some work-related education expenses can be tax-deductible or excludable from income, an employer paying for education that qualifies an employee for a new trade or business or doesn't maintain existing skills might result in a taxable benefit if not properly structured26, 27, 28, 29.
Employers should consult IRS Publication 15, "Employer's Tax Guide" for comprehensive information on their responsibilities regarding wages and tax withholding, which includes details on how reimbursements are treated for tax purposes23, 24, 25. Additionally, IRS Publication 463, "Travel, Gift, and Car Expenses," provides specific guidance on what constitutes a deductible business expense and the requirements for accountable plans19, 20, 21, 22.
Limitations and Criticisms
The primary limitation of a nonaccountable plan is its adverse tax treatment for employees. Because all payments are classified as wages, employees bear the full tax burden, including income tax, Social Security, and Medicare taxes, on amounts intended to cover business costs. This can significantly reduce the net value of the "reimbursement" to the employee. From the employer's perspective, operating a nonaccountable plan can lead to higher payroll tax obligations and increased administrative complexity related to withholding and reporting.
Another criticism is that nonaccountable plans can disincentivize prudent spending. Since employees are not required to account for their expenditures, there is less incentive to spend efficiently, potentially leading to wasteful corporate spending. Furthermore, such plans offer less transparency in tracking actual business costs.
The stringent IRS requirements for accountable plans mean that any deviation can cause an otherwise legitimate reimbursement arrangement to fall into the nonaccountable category. For example, failing to establish a clear business connection for an expense or not requiring the timely return of excess advances can jeopardize the tax-free status of the payments17, 18. This necessitates careful adherence to IRS guidelines to ensure compliance and avoid unexpected tax liabilities for both parties in the employer-employee relationship.
Nonaccountable Plan vs. Accountable Plan
The core difference between a nonaccountable plan and an Accountable Plan lies in their adherence to specific IRS requirements for expense reimbursement and, consequently, their tax treatment.
| Feature | Nonaccountable Plan | Accountable Plan |
|---|---|---|
| Taxation to Employee | Payments are included in employee's gross income; subject to federal income tax, Social Security, and Medicare taxes. Reported on Form W-2.15, 16 | Payments are generally not included in employee's gross income; tax-free. Not reported on Form W-2.13, 14 |
| Business Connection | Not explicitly required or poorly defined. | Expenses must have a clear business purpose and be incurred while performing services for the employer.11, 12 |
| Substantiation | Employee is not required to provide receipts or detailed expense reports to the employer.9, 10 | Employee must adequately account for expenses to the employer with details (e.g., amount, time, place, business purpose) within a reasonable period (e.g., 60 days).8 |
| Return of Excess Funds | Employee is not required to return any advance or allowance that exceeds actual expenses.6, 7 | Employee must return any excess reimbursement or advance within a reasonable period (e.g., 120 days).5 |
| Employee Deduction of Expenses | Generally, employees cannot deduct these expenses on their personal tax returns (due to TCJA changes for 2018-2025).3, 4 | Since reimbursements are tax-free, there's no need for the employee to deduct them. |
Confusion often arises because both types of plans involve an employer providing funds to an employee for expenses. However, the critical distinction lies in the accountability requirements. If an employer wants to provide tax-free reimbursements for legitimate business costs, they must establish an accountable plan by strictly following all three IRS rules: business connection, adequate accounting, and timely return of excess funds. Any failure in these areas will cause the arrangement to default to a nonaccountable plan, with all its associated tax consequences.
FAQs
Q1: Why are reimbursements from a nonaccountable plan taxable?
A: Reimbursements from a nonaccountable plan are taxable because they do not meet the IRS criteria for legitimate, tax-free business expense reimbursement. The IRS treats these payments as additional wages or compensation because the employer does not require the employee to prove how the money was spent or return any unspent funds.
Q2: What happens if an employer mistakenly operates a nonaccountable plan?
A: If an employer mistakenly operates a nonaccountable plan, all payments made under it become subject to federal income tax withholding, Social Security taxes, and Medicare taxes. These amounts must be reported as taxable wages on the employee's Form W-2, and the employer may face penalties for incorrect withholding or reporting if not rectified.
Q3: Can an employee deduct expenses reimbursed under a nonaccountable plan?
A: For tax years 2018 through 2025, employees generally cannot deduct unreimbursed employee business expenses on their federal income tax returns. Therefore, if an employer uses a nonaccountable plan, the reimbursed expenses are added to the employee's taxable income, and the employee typically has no recourse to claim a tax deduction for the actual expenses incurred.
Q4: Are per diem payments always considered part of a nonaccountable plan?
A: Not necessarily. Per diem payments can be part of an accountable plan if they meet specific IRS rules for "deemed substantiation" and are consistent with a reasonable business practice, requiring employees to be away from their tax home on business. If a per diem arrangement fails to meet these criteria, it would then be considered a nonaccountable plan1, 2.