An accountable plan is essentially a formal reimbursement arrangement that allows the S-Corp to pay employees and shareholders for their business expenses personally incurred. Your accountable plan must meet 3 requirements to meet the IRS’ standard (and should apply Section 1.62-2(d)(1) regulations).
Accountable plans provide a structured and legal way to deduct reimbursements for necessary expenses (like home office use and mileage) that would not typically be deductible by shareholders and/or employees on their personal tax return due to the change in the tax code with the Tax Cuts and Job Act. As long as the S-Corp and the shareholder/employees follow the accountable plan’s rules, the reimbursements are counted as valid business deductions, and the reimbursements are tax-free to the shareholder/employee.
Without an accountable plan, you’re operating with what’s called a nonaccountable plan, and under that plan, tax law requires that these reimbursements be reported on the shareholder/employee’s W2 as taxable income. Moreover, with the Tax Cuts and Job Act, you’re not even able to deduct them as miscellaneous itemized deductions anymore, so employees would have additional income, and no additional deductions.
From the Employer’s Point of View
To offer an Accountable Plan, an employer must comply with three standards:
- The expenses must have a business connection;
- The expenses must be substantiated within a reasonable period; and
- The employee must return any money not spent to the employer, also within a reasonable period.
If any of the three conditions are not met, the reimbursement arrangement is treated as a non-Accountable Plan. In other words, the reimbursements are taxable compensation to the employee and subject to employment taxes.
You should also know, reimbursing an expense does not change the deductibility of the expense itself. For instance, meals may be reimbursed at 100% of the cost, even though the expense is only 50% deductible by the company. Entertainment expenses are no longer deductible as such at all under the TCJA (Sec. 274(a)(1)). If an employer reimburses entertainment expenses, the reimbursement must be treated as wages (Regs. Secs. 1.62-2(c)(5) and 1.62-2(d)). Examples of nondeductible entertainment expenses under the TCJA include (Regs. Sec. 1.274-2(b)(1)(i)):
- Cocktail lounges;
- Country clubs;
- Golf and athletic clubs;
- Sporting events; and
- Hunting and fishing
From the Employee’s Point of View
1) The expense must have a business connection. If it’s mileage, it needs to be for business-related driving. If it’s meals, it needs to be meals to meet with clients or potential clients. If it’s travel, it needs to be for business.
If it’s a mixed-use expense, like home office expenses, home internet and/or cell phone, the reimbursement must be for the business-portion only. Note that a square footage-based allocation method may not always be appropriate for mixed-use expenses. The IRS does allow reasonable allocation methods, and that can be the actual business-use percentage, or any other reasonable method that can be consistently applied.
- Cell Phone: May reimburse full-time employees up to 70% of monthly personal costs
- Home Office Internet: May reimburse full-time employees up to 70% of monthly personal costs
- Home Office Mortgage Interest/Rent: May reimburse owners up to 20% of monthly personal costs
- Home Office Gas/Electric: Reimburse full-time employees up to 20% of monthly personal costs
2) You must substantiate the deduction with documented support. Receipts, expense exports and explanations of business purpose are key to substantiating these deductions.
3) Excess reimbursements over actual expenses must be promptly repaid. If the S-Corp’s accountable plan allows for advances to the shareholder, any excess over the actual expenses must be promptly repaid by the shareholder to the S-Corp within 120 days.
In summary, draft an accountable plan, revise and communicate updates as you see fit and sign it. Once in place, make a schedule – every month or quarter, shareholders/employees should turn in detailed expense reports with receipts and explanations, and the S-Corp should pay those reimbursements to the shareholder/employee.
It can be a win-win. The S-Corp may be able to deduct the expenses, and the shareholders get a tax-free reimbursement.
Download Your Sample Accountable Plan
At Assemblage LLC, we offer Bookkeeping & Accounting Services to small and medium-sized businesses. Plus, we now have a Sample Accountable Plan that you can purchase on our online store! Download the sample, and easily edit it in Microsoft Word format.
If you need any assistance on your accountable plan, we are here for you! Contact us today to get started.