Employees Expense Reimbursements: Beware of IRS’s accountable plan requirement!

Under IRC sections 62(a)(2) and 62(c), reimbursements for travel (including amounts allowable under established per diem rates) that meet established tests for an accountable plan, are not subject to employment taxes (federal income tax withholding, social security and Medicare).

The following are the three requirements for an IRS-recognized accountable plan:

  1. There must be a business connection and the expense must be reasonable.
  2. There must be reasonable accounting for the expenses claimed (i.e. recordkeeping).
  3. Any excess reimbursements must be repaid in a reasonable time.

For Test #2, amounts paid up to the allowable federal per diem rates for meals, expenses for incidental expenses and lodging are deemed substantiated without the usual requirements for keeping records of the expenses with receipts or logs.

The Regulations provide that in addition to these three tests, the plan cannot exhibit a “pattern of abuse.” Regulation 1.62-2(k) states that:  If a payer’s reimbursement or other expense allowance arrangement evidences a pattern of abuse of the rules of section 62(c) and this section, all payments made under the arrangement will be treated as made under a nonaccountable plan.

An employer who reimburses employees for travel expenses should be aware of the accountable plan rules and tracking requirements, and understand that amounts paid under nonaccountable plans will be deemed to be wages, reportable on Form W-2 and subject to income tax withholding, social security and Medicare taxes. In this case the employer would be liable for penalties and interest on taxes assessed for prior periods. If the anti-abuse requirements are not met, an otherwise accountable plan may be deemed nonaccountable and all reimbursements could be deemed wages subject to tax.

For more details see Publication 15, Employer’s Tax Guide (Circular E),
Madina Traore, Bookkeeper