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Accounting for employee expenses.

The Internal Revenue Service has always been leery of business expenses. The servie has long felt these expenses could be subject to abuse. Taxpayers could use the rules in this area of the law to avoid paying taxes, by giving employees (taxable) compensation disguised as (nontaxable) reimbursements.

To combat these perceived abuses, Congress recently amended the rules affecting the deduction of reimbursed amounts. Currently, employee business expenses are deductible only if reimbursed under an "accountable plan."


An accountable plan is a reimbursement or other expense allowance arrangement in which an employee must substantiate for his employer (the person making the reimbursement) the expenses covered by the arrangement. To meet this definition, a plan must meet three criteria.

Business connection. The arrangement must provide advances, allowances (including per diems, allowances for meals and mileage allowances) or reimbursements for job-related business expenses paid or incurred by the employee. There must be some connection between the advance and the business expense expected to be incurred. In addition, if a payment includes both wages and a reimbursement, a separate payment for the allowance must be made or the amount of the reimbursement must be specifically identified.

Substantiation. The employee must be required to substantiate each business expense to the employer within a reasonable period of time. Certain costs, such as travel, entertainment or automobile use, are already governed by section 274(d); under these rules, amount, time, place and business purpose must be substantiated. For other expenses, the employee must submit enough information to enable the employer to identify the specific nature of each expense and to conclude that the expense is attributable to the employer's business activities.

Returning excess expenses. An employee must be required to return, within a reasonable time, any amount in excess of the expenses substantiated. An advance arrangement satisfies this requirement only if the advance is reasonably calculated not to exceed anticipated expenses, is made within a reasonable time before the expenses are incurred (or paid) and if any excess is required to be returned to the employer within a reasonable time after the advance is received. An employee is not required to return excess amounts if receiving per diem or mileage allowances; these amounts are deemed substantiated (provided the allowance is reasonably calculated not to exceed the employee's expenses and he or she must return any portion attributable to days or miles not substantiated).

Reasonable period of time. The determination of what is reasonable generally depends on the facts and circumstances of each situation. However, two arrangements automatically, qualify as reasonable. Under a "fixed date method," an advance made within 30 days of when a payment is made, an expense substantiated within 60 days after it is paid or incurred or an excess amount returned within 120 days after the expense is paid or incurred will be considered made within a reasonable time. In addition, under a "periodic statement method," if an employer provides employees with statements at least quarterly of the amounts paid in excess of substantiated expenses and requests substantiation of any additional amounts or return of the excess, the expenses substantiated or amounts returned will be considered made within a reasonable time.


If a plan does not satisfy all three requirements for a reimbursement or other expense allowance arrangement, all amounts paid (whether substantiated or not) are treated as paid under a nonaccountable plan. These amounts must be included in the employee's gross income, must be reported to the employee on his form W-2 and are subject to withholding and employment taxes. If an employee can substantiate these costs, he may claim a deduction for them. However, the deduction may be taken only as a miscellaneous itemized deduction, subject to the 2% of income floor and the 80% limitation on meal and entertainment expenses.

Note: Employers must begin to withhold on amounts paid under a nonaccountable plan as of July 1, 1990.

For a discussion of the new developments in this area, see "Employee Business Expense Reimbursements," by Susan Nordhauser and Amy Dunbar, in the July 1990 issue of The Tax Adviser.
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Author:Fiore, Nicholas J.
Publication:Journal of Accountancy
Date:Jul 1, 1990
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