A reimbursement or allowance arrangement is a system by which you pay the advances, reimbursements, and charges for your employees’ business expenses. How you report a reimbursement or allowance amount depends on whether you have an accountable or a nonaccountable plan. If a single payment includes both wages and an expense reimbursement, you must specify the amount of the reimbursement.
These rules apply to all ordinary and necessary employee business expenses that would otherwise qualify for a deduction by the employee.
Accountable plan.
To be an accountable plan, your reimbursement or allowance arrangement must require your employees to meet all three of the following rules.
- They must have paid or incurred deductible expenses while performing services as your employees. The reimbursement or advance must be payment for the expenses and must not be an amount that would have otherwise been paid to the employee as wages.
- They must substantiate these expenses to you within a reasonable period of time.
- They must return any amounts in excess of substantiated expenses within a reasonable period of time.
Amounts paid under an accountable plan aren’t wages and aren’t subject to income, social security, Medicare, and FUTA taxes.
If the expenses covered by this arrangement aren’t substantiated (or amounts in excess of substantiated expenses aren’t returned within a reasonable period of time), the amount paid under the arrangement in excess of the substantiated expenses is treated as paid under a nonaccountable plan. This amount is subject to income, social security, Medicare, and FUTA taxes for the first payroll period following the end of the reasonable period of time.
A reasonable period of time depends on the facts and circumstances. Generally, it is considered reasonable if your employees receive their advance within 30 days of the time they incur the expenses, adequately account for the expenses within 60 days after the expenses were paid or incurred, and return any amounts in excess of expenses within 120 days after the expenses were paid or incurred. Also, it is considered reasonable if you give your employees a periodic statement (at least quarterly) that asks them to either return or adequately account for outstanding amounts and they do so within 120 days.
Nonaccountable plan.
Payments to your employee for travel and other necessary expenses of your business under a nonaccountable plan are wages and are treated as supplemental wages and subject to income, social security, Medicare, and FUTA taxes. Your payments are treated as paid under a nonaccountable plan if:
- Your employee isn’t required to or doesn’t substantiate timely those expenses to you with receipts or other documentation,
- You advance an amount to your employee for business expenses and your employee isn’t required to or doesn’t return timely any amount he or she doesn’t use for business expenses,
- You advance or pay an amount to your employee regardless of whether you reasonably expect the employee to have business expenses related to your business, or
- You pay an amount as a reimbursement you would have otherwise paid as wages.
Source: IRS Publication 15