Employee Business Expenses by Employee Business Expenses by Don Fitch CPA CITP (877)CPA-Help or (877)272-4357 Website www.Paylesstax.com

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Employee Expenses

ACCOUNTABLE AND NON-ACCOUNTABLE PLANS

(a) GENERAL DEFINITIONS

Code Section 62(a)(2)(A) allows an employee to deduct "above the line" (i.e., deduct from gross income in determining adjusted gross income
(AGI)) only those business expenses that are paid or incurred by the employee under a reimbursement or other expense allowance arrangement with an employer. Expenses are considered to be paid or incurred under a reimbursement or other expense allowance arrangement only if it is an accountable plan under which the employee must substantiate the expenses to the employer and return (and the employee does return) any amount in excess of the substantiated expenses.

In general, an accountable plan is a plan that requires (1) employees to substantiate expenses, (2) any amounts in excess of substantiated expenses to be returned to the employer, and (3) a business connection between the amounts advanced and the expenses incurred. Reg. Section 1.62-2(c)(2).
These requirements are applied on an employee-by-employee basis. Thus, the failure by one employee to substantiate expenses under an arrangement will not affect the way amounts paid to other employees are treated. Reg. Section 1.62-2(i).

CAUTION: But as to that employee, the plan will be treated as part accountable and part non-accountable.

OBSERVATION: An employer can have an accountable plan with regard to some reimbursement expenses and a non-accountable plan for other reimbursed expenses. Multiple arrangements are also permitted (accountable plans as to some employees and non-accountable as to others). Reg. Section 1.62-2(j) Example 2.

If a reimbursement or other expense allowance arrangement meets these requirements, the amounts paid pursuant to the arrangement are treated as paid under an accountable plan. Thus, the amounts reimbursed to the employee are excluded from the employee's gross income, are not reported on the employee's Form W-2, and are exempt from withholding and the payment of employment taxes. Reg. Section 1.62-2(c)(4). Expenses in excess of the amounts paid under the arrangement may be deducted as miscellaneous itemized deductions, subject to the 2 percent AGI floor. Reg. Section 1.62-2(c)(5).

CAUTION: The IRS has previously determined that a reimbursement plan adopted as part of a plan to reduce employee commissions qualified as an accountable plan (see PLR 199916011 ); however,
the IRS is now reconsidering the circumstances under which the concurrent adoption of salary reduction and reimbursement arrangements constitutes, in substance, a recharacterization of wages that is ineligible for accountable plan treatment. PLR 200035012. The IRS is studying and will not issue rulings or determinations as to whether amounts related to a salary reduction and under a purported reimbursement or other expense allowance arrangement will be treated as paid under an accountable plan in accordance with Reg. Section 1.62-2(c)(2), until the resolution of the issue through the publication of a revenue ruling, revenue procedure, regulations or otherwise. Rev. Proc.
2002-3, 2002-1 I.R.B. 117, Section 5.01.

Under a non-accountable plan, an employee may only deduct expenses as miscellaneous itemized deductions, subject to the 2 percent AGI limitation. Reg. Section 1.62-2(c)(5). The amounts paid by the employer under a non-accountable plan must be reported by the employer as wages in Box 1 and Box 13 of the employee's Form W-2. Non- accountable plans include arrangements that do not require employees to substantiate expenses or allow employees to keep any excess amount. Reg. Section
1.62-2(c)(3).

OBSERVATION: Unless travel and entertainment advances or reimbursements are (1) for deductible business expenses, and (2) are paid under an accountable plan, the employee will be the loser. For
example, if an employee receives a meal allowance under a non-accountable plan, the employer must include it in the employee's W-2 income. The employee may claim only 50 percent of his meal expenses as a miscellaneous itemized deduction subject to the 2 percent limitation. Reimbursements under an accountable plan, on the other hand, are not included in the employee's compensation, and the 50
percent limitation applies to the employer's deduction.

(b) QUALIFYING AS AN ACCOUNTABLE PLAN

(b)(1) Business connection

Reimbursements under an accountable plan must be for business expenses that are allowable as deductions for expenses paid or incurred by an
employee in connection with her performance of services as an employee. Reg. Sections 1.62-2(b), 1.62-2(d). There must be a connection between the amount of an advance and the amount of business expenses an employee is anticipated to incur.

The business connection requirement is not satisfied if the employer arranges to pay an amount to an employee regardless of whether the employee incurs or is reasonably expected to incur certain business
expenses. Reg. Section 1.62-2(d)(3). Thus, for example, the payment to employees of an auto repair shop for the use of their tools is not treated as paid under an accountable plan because the payments held no relationship to the expenses that the employees would incur with respect to their tools. CCM 200006005 Similarly, an advance provided at a time when it was not anticipated that the employee would incur deductible expenses does not meet the business connection requirement and is treated
as paid under a non-accountable plan. See Reg. Section 1.62-2(j), Example (5).

Where per diem payments are based on the number of hours worked, and increases in the per diem amount have no correlation to an employee's
expected travel, the payments are not tied to the expenses an employee
would reasonably be expected to incur, and therefore do not meet the
business connection test. Worldwide Labor Support of Mississippi, Inc. v.
United States, No. 3:00CV170BN (S.D.Miss. May 15, 2001). Similarly, where
a messenger service's reimbursements to its drivers are not based solely
on miles driven or mileage expenses incurred, but rather on the amount
charged to customers (which is based on distance, time required for
delivery, and waiting time, and includes additional charges for rush
deliveries and overweight items) the arrangement does not meet the
business connection requirement. Shotgun Delivery, Inc. v. United
States, (9th Cir. 2001), aff'g 85 F.Supp. 2d 962 (N.D. Cal. 2000).

OBSERVATION: Attorney's fees of former employees in wrongful
termination cases do not satisfy the business connection requirement
and thus do not qualify as having been paid under an accountable
plan. Biehl v. Commissioner, 118 T.C. No. 29
(2002).

(b)(2) Substantiation

An accountable plan must require an employee to substantiate the expenses
covered by the arrangement to the employer. Reg. Section 1.62-2(e)(1).
To the extent an employee business expense, such as travel or
entertainment, is subject to the substantiation rules of Code Section
274(d), the plan must require the employee to provide substantiation that
satisfies Code Section 274(d), including the deemed substantiation rules
discussed in Sections 29.2 and 29.3 Reg. Section 1.62-2(e)(2).

For business expenses not subject to Code Section 274(d), a plan must require employees to provide information that is sufficient to enable the employer to identify the specific nature of each expense and to conclude that the expense is attributable to business activities. Thus, each element of an expenditure or use must be substantiated. It is not sufficient for an employee merely to aggregate expenses into broad
categories, such as travel, or report individual expenses through the use of vague, non-descriptive terms, such as miscellaneous business expenses.
Reg. Section 1.62-2(e)(3). Furthermore, the IRS has indicated that an electronic receipt directly from a business charge card program does not satisfy the substantiation requirements, because it does not require the employee to submit documentary evidence of expenses that itemizes the
charge. PLR 200103015.

(b)(3) Return of excess amounts

An accountable plan must require an employee to return any amount in excess of the substantiated expenses. Whether an arrangement requires an
employee to return amounts in excess of substantiated expenses depends on the facts and circumstances. For example, an employee who uses the excess of an advance for anticipated business expenses over the amount actually incurred in order to pay expenses incurred for other business expenses does not have to return the excess to the employer. Reg. Section 1.62-2(f)(1).

(b)(4) Timeliness

Both the requirement of substantiation and the requirement that excess reimbursements be returned must be satisfied within a "reasonable" period of time after the expense is paid or incurred. What constitutes a reasonable period of time will depend on the facts and circumstances. Reg. Section 1.62-2(g). The regulations provide two safe harbor methods
for determining whether the reasonable time requirement has been satisfied (1) the fixed date method and (2) the periodic statement method.

Under the fixed date method, the timeliness requirement is satisfied if an advance is made within 30 days of when an expense is paid or incurred, an
expense is substantiated within 60 days after it is paid or incurred, or an excess amount is returned to the payor within 120 days after the expense is paid or incurred. Reg. Section 1.62-2(g)(2)(i). Under the
periodic statement method, the timeliness requirement is satisfied if an expense is substantiated or an amount is returned within 120 days after the payor provides a periodic statement (no less frequently than quarterly) of the amount paid under the arrangement that exceeds the expenses the employee has substantiated. Reg. Section 1.62-2(g)(2)(ii).

No adverse inference is intended with respect to amounts advanced, substantiated, or returned after the time periods specified in the two safe harbors. However, for purposes of withholding, an employer may treat amounts substantiated or returned after such periods as not having been substantiated or returned within a reasonable period of time. Reg.
Section 1.62-2(h)(2).