Tax Alert: Payments to Employees and Accountable Reimbursement Plans In the Spotlight Again
10/28/2009
Over the past several months, we have again seen increased IRS scrutiny of expense reimbursement plans and cash or check payments by an employer to an employee for "advances" or for other reasons. Below is a general overview of the basic rules. Please call your J.H. Cohn contact with any questions or comments.
Employer reimbursements of employee business expenses or payments of per diem, auto expenses, or for general allowances are generally subject to rules that distinguish between legitimate expense reimbursement arrangements and those that more closely resemble additional compensation.
If the employer maintains an accountable plan, expense reimbursements or expense allowances generally are deductible by the employer as business expenses, excluded from the employee’s gross income and exempt from income tax withholding and employment taxes.
If the employer does not maintain an accountable plan, expense reimbursements or expense allowances generally are deductible by the employer as employee compensation, included in the employee’s gross income, reported as wages on Form W-2, and subject to income tax withholding and employment taxes.
An accountable plan is a reimbursement or other expense allowance arrangement (“plan”) that requires employees to substantiate covered expenses and return unsubstantiated/excess advances. The following requirements are generally applied on an employee-by-employee basis, and must be met for the plan to be accountable.
1. Proving a Business Connection: The plan pays reimbursements and allowances only for otherwise deductible business expenses (such as travel, lodging, or meal expenses incurred while away overnight on business). The reimbursements and allowances must be clearly identified as such when the employee is paid.
2. Maintaining Adequate Substantiation: The plan requires substantiation of the expenses being reimbursed. The employee accounts for the business expenses by submitting to the company a detailed written record (such as an itemized receipt) of the expense.
3. Requiring Employees to Return Excess Advances. The plan requires the employee to return any advance exceeding substantiated business expenses. Any excess not actually returned is treated as compensation to the employee, subject to payroll tax withholding like any other compensation.
Situations where an employer advances by check or pays cash to an employee that is not substantiated must be included as compensation to the employee and reported as W-2 wages. In addition, the amounts are subject to withholding. It has come to our attention through some published stories in the media over the past several months that employers may make payments to employees for bonuses, working overtime, tool allowances, to cover expenses, or other seemingly reasonable business purposes. Such practices can subject both the employer and the employee to severe penalties if not properly substantiated and accounted for.
In addition, the Internal Revenue Service has announced that its National Research Program will launch a three year program of detailed Federal employer tax audits beginning in November 2009. These audits will focus on, in addition to reimbursed expenses, worker classification (employee vs. independent contractor), fringe benefits, and officer's compensation..
We encourage you to contact Joseph A. Tighe, CPA, a J.H. Cohn tax partner and a member of the Firm's State and Local Tax (SALT) Group, or your J.H. Cohn professional at 877-704-3500 with any questions or comments to ensure your reimbursement plan and policies for paying employees special bonuses, advances, and any other payments be considered an accountable plan to the Internal Revenue Service.
Joseph A. Tighe, CPA, is a J.H. Cohn tax partner and a member of the Firm's Tax Specialty Services Group with a specific focus on State and Local Tax (SALT) services, including conducting sales tax research and addressing Nexus issues. Further, as a member of both J.H. Cohn's Construction Industry Practice and Real Estate Industry Practice, his broad range of experience helps client maximize depreciation benefits by performing cost segregation studies, He can be reached via email or at 877-704-3500.
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