Accountable vs Nonaccountable Plans

Accountable vs Nonaccountable Plans: Which One Does Your Business Need?

Do you regularly provide your employees with reimbursements or allowances? If so, do you have the proper documentation procedures in place? Employee reimbursements fall under an accountable plan, while employee allowances should be outlined in a nonaccountable plan.

Understanding the basics of an accountable plan and nonaccountable plan can help your business determine where expenses paid to employees should go and how they are treated for tax purposes.

What is an Accountable Plan?

An accountable plan is a document maintained by the employer that outlines which reimbursements for business expenses are excluded from the employee’s income. Although accountable plans can be tweaked to meet your internal reporting needs, they must follow the three basic components outlined in Treasury Regulation 1.62-2:

1.      Business Connection – The plan is only allowed to reimburse employees for qualifying business expenses that were incurred in the ordinary course of

business. No personal expenses are reimbursable. Expenses that are partially related to the business, such as a business vehicle used for personal use, are

only reimbursable to the employee for the business portion. This is because only business expenses are allowed to be deducted for tax purposes.

2.      Adequate Substantiation – An accountable plan requires employees to remit substantiating documentation. This information must be submitted in a

reasonable time. IRS Publication 463  outlines that reasonable time is usually within 60 days after the expense was incurred. Your accountable plan should

outline your company’s definition of reasonable time.

3.      Return of Excess Reimbursement – When excess reimbursements occur, the employee should return the amount within 120 days, according to IRS

Publication 463. Returns of excess reimbursements often occur when the company reimburses expenses in advance of travel or purchases. For example, if an

employee booked a flight and that flight dropped in price after the reimbursement, the employee is obligated to return the excess.

These are the three foundational components of an effective accountable plan. However, your company can add on more regulations to tighten criteria.

What is a Nonaccountable Plan?

A nonaccountable plan handles all expenses that don’t meet the criteria of the accountable plan. Nonaccountable plans are commonly referred to as an allowance. For example, if an employee takes a trip out of town, the employer can provide the employee with a set allowance for expenditures that might not qualify for reimbursement under an accountable plan.

The allowance is considered taxable income and subject to payroll withholding and employment taxes. If there exists an arrangement between an employer and employee for advances, allowances, or reimbursement of business expenses that do not satisfy one or more of the basic requirements of an accountable plan, then that arrangement is treated as a nonaccountable plan.

Although these amounts are included in the employee’s gross income, expenses attributable to that taxable income are deductible by the employee subject to all applicable limitations on their individual income tax returns.

Managing Accountable and Nonaccountable Plans

An employer can have both an accountable plan for certain expenses and a nonaccountable plan for others. If you are an employee whose deductible business expenses are fully reimbursed under an accountable plan, the reimbursements should not be included in your wages on your Form W-2, Wage and Tax Statement, and you should not deduct the expenses.

However, if your employer uses a nonaccountable plan to reimburse you for the expenses, the reimbursements are includable in your wages. Your employer will combine the amount of any reimbursement or other expense allowance paid to you under a nonaccountable plan with your wages, salary, or other compensation and report the total on your Form W-2. You may deduct employee business expenses as an itemized deduction. For a definition of accountable and nonaccountable plans, refer to Pub.463.

Keep in mind that due to TCJA, the deduction for unreimbursed employee expenses on Form 2106, was eliminated for tax years 2018 through 2025 so candidates are seeking work from employers who will reimburse them or provide an allowance to cover expenses.

What is the Treatment for Each Class of Compensation?

The IRS has separate taxation rules depending on the type of transaction. Understanding the differences will help you correctly categorize the expenses under an accountable or nonaccountable plan.

Awards, Prizes & Employee Gifts

• Incentive awards are generally taxable.

• Sales awards are wages for employment tax purposes.

• Income tax withholding is only optional for commissionable salespeople.

• Suggestion awards are wages subject to employment taxes.

• Achievement awards are excludable up to $1,600 ($400 for awards that are not “qualified plan awards).

• Holiday gifts are presumed to be compensation.

• Gifts to employees that are not regarded as de minimis must be included in the employee’s gross pay on Form W-2.

• An exception includes certain awards such as Pulitzer or Noble Peace Prize awards that have been transferred to charities.

Note: If awards exceed limitations, the entire amount becomes taxable.

De Minimis Fringe Benefits

Refers to benefits excluded from the employee’s income (IRC Section 132(e)) when the employer provided property or services have such small value and frequency that accounting for them would be impractical. These de minimis rules do not apply to cash & cash equivalents such as gift cards or memberships in private country clubs or athletic facilities. The following are examples of fringe benefits:

• Employee cocktail parties

• Company picnics

• Office coffee, soft drinks & snacks

• Occasional meals provided to employees during meetings

• Occasional business meals involving only employees

• Occasional use of the copy machine

• Company product samples

• Employer –Provided Cell Phones

If your business has any of these employee expenses, it’s important that you define which plan they fall under. For more information on the limits for 2% shareholders, check out our other paper here.

Summary

Differentiating between an accountable and nonaccountable plan is important to determine which one your business needs. In the event of an IRS audit, they will look back at your internal controls surrounding employee reimbursements and allowances.

Without a defined accountable and nonaccountable plan, your business may face stiff fines and penalties. To work through the proper setup of these plans, reach out to one of our team members today.

Adopt an Accountable Plan Today