If you are an owner-employee or have employees, it is important to know the tax rules for employee business expenses. In this segment of our Tax Update, we will explain the reporting and deduction requirements for expenses incurred by employees in connection with your business.
Common employee expenses include business meals, supplies, travel away from home, and education. The tax treatment of these expenses depends on whether you are reimbursed for your costs, and if so, under what type of arrangement.
If your employment-related expenses are not reimbursed by your employer, they may be deductible to you as a miscellaneous itemized deduction. They are grouped together with other miscellaneous items on your tax return. Only the total amount of these miscellaneous items exceeding 2% of your adjusted gross income (AGI) is deductible as an itemized deduction. Therefore, you will lose some of the deduction to the 2% floor and could even end up not being able to deduct any of the expenses depending on how high your AGI is for a particular tax year.
If your expenses are reimbursed by your employer, they are reimbursed either under an accountable plan or a nonaccountable plan. The type of reimbursement plan you are under will dictate the tax treatment of your expenses.
An accountable plan reimburses employees with the requirement that the employee record and provide an expense record as well as receipts or other documentation supporting the details of each expense. An accountable plan may also exist if the employer pays a per diem allowance. Any payments received in excess of actual costs incurred must be returned to the employer in order for the plan to qualify as accountable. If you receive reimbursements under an accountable plan, the transaction is treated as a wash. The reimbursement is not included as income on the employee’s W-2, and the amount of expenses reimbursed is not reported on the employee’s tax return.
A nonaccountable plan is a plan that does not require the employee to submit records or documentation of expenses to the employer. Employers with a nonaccountable plan may provide employees with an expense allowance to use for any expenses they may incur. In this type of arrangement, the employer reports the allowance as wages on the employee’s W-2 for the year. The employee will deduct the expenses they incur as miscellaneous itemized deductions subject to the 2% floor as discussed above. This type of scenario can be very unfavorable for the employee.
Consider the following example. John was paid $45,000 in wages in 2016 and his employee expenses for the year totaled $1,000. Assuming he had no other miscellaneous itemized deductions and was reimbursed by his employer under a nonaccountable plan, John will report W-2 wages of $46,000, which includes the $1,000 expense reimbursement. John’s AGI, including the reimbursed expenses report on his W-2 was $55,000. Since 2% of John’s AGI is $1,100, he is not able to deduct any of his employee expenses. He must still recognize the income, but is not able to claim the deduction.
As you can see, whether the employee is reimbursed for employment-related expenses, as well as, what is the type of reimbursement plan are two factors which can have a significant consequence in this area of the tax law. If your business currently has a nonaccountable plan, you may consider implementing an accountable plan or cover the costs directly. An experienced CPA can help you evaluate these options, as well as assist with implementation.
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