Accountable Plan IRS: S Corp 3 Rules and Benefits

As an employer, you might be losing out on saving on payroll taxes and your employees might be missing out on being reimbursed tax free.  If you aren’t reimbursing employees for employer related expenses, your employees will have to eat those costs all together. You see, before 2018, employees were able to receive a deduction on their personal tax returns for expenses incurred on behalf of their employer. But now these expenses are no longer allowed as a deduction on personal tax returns up through the 2025 tax year.

While it is possible that this deduction might be reinstated after 2025, it’s still not ideal to have your employees deduct employer related expenses on their personal returns. You have to keep in mind that some employees aren’t able to itemize their deductions, so these employees would be eating the entire costs.  If the deduction is reinstated after 2025 and an employee is able to itemize, the employee is still going to have to absorb some of the costs because the employee would only be able to deduct unreimbursed employee expenses that exceed 2% of his adjusted gross income.

Now, let’s be honest, most S Corporation shareholders are really interested in making sure that they themselves can maximize the benefit of receiving reimbursements for employer related expenses. And there is nothing wrong with that.  You should take advantage of any gift that Congress gives to you. So on to the tax strategy.  As you know, as a S Corporation shareholder, you are also an employee. So, you will be wearing your employee hat for this strategy.  You want to reimburse every expense possible to yourself as an employee.  For S Corporations, the best expense reimbursement strategy is through an Accountable Plan.

If the employer establishes an Accountable Plan, the employer can reimburse employees for expenses without treating those reimbursements as W2 wages. So, this means no payroll taxes for the employer and tax free reimbursements for the employee.  And the employer still gets to take a deduction.

Some examples of expenses that can be reimbursed are:

union dues, Uniforms, vehicle mileage and education expenses relating to the employees current position.

A home office deduction that is based on the square footage of the residence that is separately identifiable and is used as the principal place of business for the employee.

Internet access based on the percentage used for business. You want to be careful here because an IRS auditor would want you to have documentation of the amount of hours actually worked by the employee.

Another expense would be 100% of basic cell phone charges.  You absolutely must make sure that you are only reimbursing for a basic plan because tax examiners look at this expense very closely. Anything beyond the basic plan, can not be reimbursed under an accountable plan.

Another category of expenses would be computers. printers, monitors, – these type of items.  This category is a little tricky.  When it comes to reimbursements for computers, you really have to take a look at how the employer plans to handle the deduction on the return.  There is bonus depreciation, versus safe harbor, versus whether reimbursements will cause any type of recapture if Section 179 depreciation is taken by the employer. Recapture under 179 can happen if an employee is reimbursed for his personal computer and then later only uses the computer for less than half the time for his employer.

Accountable Plan Rules

There are the 3 conditions required for expenses to be reimbursed tax free.

1. There always must be a business connection for expenses to be reimbursed.  For instance, for some reason, a lot of people try to slip in expenses relating to their pets.  No, you can’t do things like that.

• Employees must submit documentation of the expenses within a reasonable amount of time. Most IRS auditors look for a period of 60 days or less of when the expense was paid or incurred.

• If employees are advanced funds versus being reimbursed for expenses, the employee must return any excess over the amounts that actually have been expensed.  A tax auditor will usually check to see if any excess amounts were paid back to the employer within 120 days.

Here are the steps to take to establish an Accountable plan.

1.  Decide what employees will be included in the plan.  It can be only the shareholders or just select employees.  It’s whatever you want to do.  You don’t have to include all employees.

• Although it’s not required, it is highly recommended that you put the plan in writing by creating an Accountable Plan Policy.

• Provide each employee, who will be included in the plan, with a way to summarize and submit expenses.

• Have each employee submit their expenses monthly, along with their receipts, invoices, and billing statements to the employer so that they can receive reimbursement.

Be sure to remind your employees that they can not deduct any expenses reimbursed by the employer on their personal return. So basically no double dipping. For example, the portion of homeowner interest payments reimbursed by the employer for home office expense can not be deducted on a personal return but the non-reimbursed amount can be deducted.

Before you, as the employer, decide to reimburse for any expense, please research the rules regarding what qualifications have to be met in order to deduct that particular expense.

Before we wrap up, I do want to give you my opinion regarding advancing funds to employees for anticipated expenses versus reimbursing for those expenses.

While providing an allowance to employees for cell phones, internet, and computer expenses is acceptable, I prefer reimbursements instead of an allowance and here are couple of reasons why:

First, an allowance is scrutinized more extensively by IRS examiners.  If an examiner determines that allowances are not being handled properly, those reimbursements will be reclassified as W2 wages. So, after an audit, employees would have to go back and include the income in their wages and the employer would have to pay payroll taxes along with penalties and interest for a late payment of those payroll taxes.

Secondly, any excess amounts that were advanced to employees must be returned to the employer. So, if an employee can’t pay back any excess of an advance that was made to him, the employer runs the risk of the plan being declared as a Non-Accountable Plan.  So again, this would mean that all reimbursements and advances would have to be reclassified as wages.  So to me, reimbursements are a safer option.

Now that you understand how an accountable plan can save on payroll taxes and personal income taxes, I hope that you will consider it as part of your tax strategy for your corporation.

If you are interested in an accountable plan template and a monthly reimbursement Excel spreadsheet to use for your own plan, we have created some documents that can help you get started.  As a bonus, we have also included a memo letter that you can use as a response to an IRS auditor if they propose an adjustment because you deducted 100% of basic cell phone usage.