Don’t Let Expense Report Blunders Trigger Unnecessary Taxes, Punishing You and Your Employees

Estimated Tax Tip Savings

Consider this scenario: You or one of your employees submits $12,000 worth of expenses to the IRS, which unfortunately categorizes them as wages rather than expense reimbursements. Consequently, this oversight results in an extra $4,836 in taxes.

Typically, when employees incur expenses on behalf of your business, you reimburse them and deduct the expenses. This is a common and acceptable practice, provided you adhere to the IRS expense reporting rules known as the "accountable plan" rules.

However, if you fail to comply with these rules, which unfortunately many business owners do, you open yourself and your employees up to significant additional taxes, potentially costing thousands of dollars unnecessarily. This situation is exacerbated if your business operates as an S or C corporation because, as both a business owner and an employee, you're subject to IRS scrutiny from both angles.

But here's the silver lining: By implementing straightforward safeguards, you can avoid these additional costs and keep your employees satisfied. We offer a turnkey process that streamlines the implementation of this crucial strategy, ensuring peace of mind and financial efficiency for your business.

Reimbursements Versus Wages

Normally when you pay an employee, you pay him or her wages, which are subject to employment taxes and income taxes.

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.

1. You or your corporation deducts the expenses that the employee submits for reimbursement.
2. The reimbursement is tax-free to the employee.
   
   

However, without a proper accountable plan, the IRS treats the reimbursements as wages for tax purposes. 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.

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 must follow the accountable plan rules when you incur expenses on behalf of the corporation.

Follow the Accountable Plan Rules

The accountable plan rules create a roadmap to getting your (and your corporations, 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 three major requirements:

1. Business Connection: The expense must be a deductible business expense that arises during business operations.
2. Substantiation: Employees must submit to the employer all elements of proof that tax law requires for that expense.
3. 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.

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.

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 report after you incur an expense.

The law simply requires employees to substantiate their expenses to the employer, not to fill out a formal expense report. However, the expense report is a handy way to ensure that you complete all the elements of proof that the law requires for given expenses.

One additional requirement is the reimbursements must be timely. You and your employees must complete all stages of the reimbursement process in a timely fashion. The IRS wants 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 that timeliness is determined by the “facts and circumstances” of each situation. To help provide some certainty, the IRS gives you safe harbors that it always considers timely:

• Advances made within 30 days of when an expense is paid or incurred.
• Substantiation of expense made within 60 days after expense is paid or incurred.
• Returns of amounts more than the amount of substantiated expenses made within 120 days after an expense is paid or incurred.
• Substantiation of expense or returns of excess amounts made within 120 days after the receipt of a periodic statement (if the periodic statement is made at least quarterly).

Tools That You Can Use

We have created:

1. A sample accountable plan
2. An expense report that you can use and 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 expenses you incur in your business.

Takeaways

 Make certain that you subject your employees to an expense reporting requirement. And if you operate your business as a corporation, make sure that your corporation requires expense reporting by all employees, including you, the owner-employee.

If you do this and follow the easy guidelines in the accountable plan rules, you can sleep at night knowing that you are not putting yourself or your employees in tax peril.



Tax peril is bad because it makes employees unhappy. You can create those unhappy employees when you, because of your or your corporation’s carelessness, made your employees pay more in taxes than they should have.