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Payroll Reimbursement Plans

Based on Internal Revenue Service (IRS) guidelines, to be considered part of an accountable plan, reimbursements must meet the following conditions:

  • The employee's reimbursed activities must have a direct connection to the business and the job responsibilities.
  • The employee must provide an accurate accounting to you as the employer of how the reimbursement money was spent.

Typically, an employee will use an expense report to provide this type of information with receipts as substantiation. Expenses over $75 and all lodging expenses require a receipt or some other documented proof of spending. Employees need to return any excess reimbursements within a reasonable period of time.

Non-accountable reimbursement plan

An employer's reimbursement plan is considered non-accountable if it fails to meet any of the requirements of an accountable plan.

The difference between an accountable and a non-accountable plan is how the payments are treated for tax purposes — they are either included as income or excluded. For accountable plans, the reimbursement or excess amount is excluded from income and is not subject to withholding taxes. In non-accountable plans, the reimbursement or excess amount is included in income and subject to withholding taxes.

Even if the employer has an accountable plan, it is still possible that some payments will be treated as non-accountable. This occurs in cases when an employee fails to return excess reimbursements. It also applies to the reimbursement of non-deductible expenses related to the employer's business.

If you have an accountable plan, and an individual employee fails to substantiate their expenses, your plan does not automatically become non-accountable for all of your employees. It would only apply to the non-complying employee. Likewise, if you have elements of both accountable and non-accountable plans as part of your reimbursement program, the IRS allows for each of the respective elements to be treated on their own.

Unused, excess reimbursements

As a small business owner, keeping an accurate accounting of how money is being spent with regard to your company is essential. This is one of the reasons that it is important to get any unused reimbursements from your employees as quickly as possible. However, the IRS has established two safe-harbor methods related to employee substantiation and return of excess funds within a reasonable period of time.

Using the fixed-date method, the reasonable time period is met if an advance is provided no more than 30 days before incurring an expense and it is substantiated by your employee within 60 days of being paid or incurred. Also, any extra amount is actually returned within 120 days of when the expense was paid or incurred.

With the periodic statement method, you can issue a periodic statement (at least quarterly) to the employee detailing reimbursements that have been paid but yet to be substantiated. You have the right to expect the employee to substantiate the excess amount or return it to you with 120 days of receiving the statement.

Reimbursement tax

The IRS has stated that Congress had not meant for the partial deduction allowance to become employee income. Therefore, assuming the accountable plan requirements are met, the full amount of reimbursements or advances are not considered employee income subject to federal income tax withholding, Social Security, Medicare or Federal Unemployment Tax Act (FUTA) purposes.

Any payments made as part of a non-accountable plan are subject to federal income tax withholding, Social Security, Medicare and FUTA taxes. Also, payroll combines the total or any reimbursements or other expense allowances paid as part of a Non-accountable plan to the employee's wages, salary or other pay. This information will be provided on Form W-2.