Corporate Reimbursements to Employees-Tax Avoidance Strategy or Trap

April 21st, 2015 at 3:31 PM

When an employee expends money on behalf of your business, you are allowed to reimburse them and deduct the expense. If you follow the IRS expense reporting rules that are referred to as “accountable plans”, that’s a perfectly acceptable practice. However, if you are documenting these transactions, it may result in thousands of dollars of unnecessary taxes.

The accountable plan rules create a road map to getting your expense reporting requirements in good order for tax purposes. Tax rules do NOT require a written plan. However, your corporation should put the plan in writing to make it usable for your employee and yourself. There are 4 major requirements that need to be addressed:

1. Business Connection-The expense must be a deductible business expense that arises in your business.
2. Substantiation-Employees must submit to the employer all elements of proof that the tax law requires to document the expenditure.
3. No Excess Payment-The employee must return any excess advance or reimbursement within a reasonable time, or the IRS will tax the excess payment as wages.
4. Timely Reimbursements- Documentation must be timely according to “facts and circumstances” of each situation.

The tax law simply requires employees to substantiate their expenses to the employer, not to fill out a formal expense report. However, the expense report is an excellent way to ensure the complete elements of proof. Therefore, I recommend a formal expense report.

This is an extremely sensitive area of the tax law, and can be a veritable “time bomb” if not properly adhered to. If you operate as an S or C Corporation, and you do not have an accountable plan, the IRS will reclassify these expenditures as wages to the employee as compensation–the wage classification triggers additional employment taxes for you and your employee—OUCH!

This will make your employee furious, costing you thousands of dollars in payroll taxes as well.