Accountable Plan Rules. Don’t Let Expense Report Blunders Trigger Unnecessary Taxes, Punishing You and Your Employees
- Viktoriya Barsukova, EA, MBA
- Oct 23
- 5 min read
Estimated Tax Tip Savings
Imagine this: you (or one of your employees) submit $12,000 of expenses that the IRS deems wages, not expense reimbursements, causing $4,836 in extra taxes.
When employees spend money on behalf of your business, you probably reimburse them and deduct the expense.
That’s a perfectly acceptable practice—if you’re following the IRS expense reporting rules, which tax law calls the “accountable plan” rules.
However, if you don’t follow these practices—and many business owners do not—you’re exposing yourself and your employees to thousands of dollars in additional, unnecessary taxes.
Even worse, if you operate your business as an S or a C corporation, you are an employee too, which means the IRS will hit you twice—as both a business owner and an employee!
But here’s good news: with some straightforward safeguards in place, you don’t have to worry about additional costs or unhappy employees.
In fact, we are going to give you two tools that you can use to seamlessly integrate the accountable plan expense reporting safeguards into your business routine.
Reimbursements Versus Wages
Normally when you pay an employee, you pay wages, which are subject to employment taxes and income taxes.¹
But wages do not generally include amounts paid to employees to properly reimburse them for expenses incurred in the course of their employment.
With a proper reimbursement:
You or your corporation deducts the expenses that the employee submits for reimbursement; and
The reimbursement is tax-free to the employee.
However, without a proper accountable plan, the IRS treats the reimbursements as wages for tax purposes.²
Although you or your corporation, as the employer, can still deduct this amount as compensation, the wage classification triggers additional employment taxes for both the employer and the employee.
Furious Employees
How would you feel if you received an expense reimbursement that turned into fully taxable income—particularly since proper reimbursements are tax-free to employees?
Don’t answer yet. This gets worse.
First, both the employee and the employer suffer payroll taxes.
Second, you deduct the reimbursement that’s now on your W-2 as an unreimbursed employee expense using IRS Form 2106.
With the Form 2106 deduction, you (if incorporated) or your employee will suffer in one of three ways:
No deduction (zero, nada) if you are subject to the alternative minimum tax (AMT).
No deduction if you or your employee does not itemize deductions.
Deduction only to the extent that miscellaneous itemized deductions exceed 2 percent of adjusted gross income.
Corporation Owners Are Employees
If you operate your business as an S or a C corporation, you are an employee of the corporation.
That means you and the corporation have to follow the accountable plan rules when you incur expenses on behalf of the corporation.
Example for the S Corporation Owner
You own an S corporation and take a trip out of town each month to visit suppliers and other business associates.
Your transportation and lodging expenses cost you $1,000 each trip ($12,000 total for the year), and your S corporation reimburses you for these amounts.
Here is what happens when you violate the accountable plan rules:
The corporation treats the reimbursement as wages, which creates $1,836 of additional employment taxes($12,000 x 15.3%).
The corporation deducts the payment as compensation.
You, as an employee, treat the expense as an itemized deduction, where one of three possible bad things happens (as mentioned above).
Let’s say you do not itemize, so you lose 100% of your deduction.
In the 25% tax bracket, this means you lose $3,000 of income tax savings ($12,000 x 25%).³
Overall, the cost for violating the accountable plan rules is $4,836 ($1,836 in payroll taxes plus $3,000 in income taxes).
Follow the Accountable Plan Rules
The accountable plan rules create a roadmap to getting your (and your corporation’s, if incorporated) expense reporting requirements in good order for tax purposes.
Tax rules do not require you to create a written accountable plan.
However, you or your corporation should put the plan in writing to make it clear and usable both for you and your employees.
(And should the IRS come knocking, your written plan puts you in the driver’s seat.)
There are four major requirements:⁴
Business connection. The expense must be a deductible business expense that arises in the course of business.
Substantiation. Employees must submit to the employer all elements of proof that tax law requires for that particular expense.
No excess payment. The employee must return any excess advances or reimbursements within a reasonable time, or the IRS will tax that excess payment as wages.
Timeliness. Reimbursements and substantiation must be timely, as explained below.
Of course, once you establish the plan, you must also do what the plan says.
The IRS may invalidate the plan if you show a pattern of disregarding the rules.⁵
Expense Reports Put It All Together
One way to ensure that you and your employees comply with the accountable plan rules is to fill out an expense reportafter you incur an expense.
The law simply requires employees to substantiate their expenses to the employer, not to fill out a formal report.
However, the expense report is a handy way to ensure that you complete all the elements of proof that the law requires.
Be On Time
You and your employees must complete all stages of the reimbursement process in a timely fashion.
The IRS prefers your records to be as close in time to the actual expenses as possible—and this makes for better proof.
What does timeliness mean, specifically?
The IRS says it’s determined by the “facts and circumstances” of each situation.
To help provide certainty, the IRS gives safe harbors that it always considers timely:⁶
Advances made within 30 days of when an expense is paid or incurred.
Substantiation of expense made within 60 days after the expense is paid or incurred.
Returns of excess reimbursements made within 120 days after an expense is paid or incurred.
Substantiation or returns of excess amounts made within 120 days after receiving a periodic statement (if the statement is issued at least quarterly).
Tools That You Can Use
We have created:
A sample accountable plan
, and
An expense report you can adapt to your business needs.
In the sample accountable plan, you will find:
The basic statement of the plan and the rules on timeliness, and
A table listing the substantiation requirements for many common business expenses.
Takeaways
Make certain that you require your employees to complete expense reports.
And if you operate your business as a corporation, make sure your corporation requires expense reporting by all employees, including you, the owner-employee.
If you follow these easy accountable plan rules, you can sleep well knowing you’re not putting yourself—or your employees—into tax peril.
Tax peril is bad because it makes employees furious.
You can create those furious employees when you (or your corporation) carelessly make them pay more in taxes than they should have.
Footnotes:
See IRC Section 3306(b).
IRC Sections 62(a)(2)(A); 62(c); Reg. Section 1.62-2(c)(4).
For simplicity, this example ignores the $230 additional income tax deduction you receive by virtue of paying additional employment taxes ($6,000 x .153 x .25).
Reg. Section 1.62-2.
Reg. Section 1.62-2(k).
Reg. Section 1.62-2(g).
This information is based on materials from Bradford Tax Institute.
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