Expense Reimbursement Plans

An accountable plan is a reimbursement or other expense allowance arrangement that requires employees to substantiate covered expenses and return unsubstantiated advances.  The following requirements are generally applied on an employee-by-employee basis, and must be met for the plan to be accountable:

1. Proving a Business Connection. The plan pays reimbursements and allowances for otherwise deductible business expenses (e.g., travel, lodging, or meal expenses incurred while away overnight on business). The reimbursements and allowances must be clearly identified as such when the employee is paid.
2. Maintaining Adequate Substantiation. The plan requires substantiation of the reimbursed expenses. The employee accounts for the business expenses by submitting to the company a detailed written record (such as an itemized receipt) substantiating the expense's time, place, amount, and business purpose.
3. Requiring Employees to Return Excess Advances. The plan requires the employee to return any advance exceeding substantiated business expenses within 120 days. Any excess not actually returned is treated as compensation to the employee and is subject to payroll tax withholding like any other compensation.

If your plan meets the requirements for an accountable plan, expense reimbursements to employees are deductible by the employer as business expenses. These reimbursements are excluded from the employee's gross income, not reported as wages or other compensation on the employee's Form W-2, and exempt from employment taxes.  

If the plan is non-accountable (i.e. does not meet all requirements for an accountable plan), the employer deducts employee expense advances or reimbursements as compensation rather than business expenses. The payments are included in the employee's gross income, reported as wages on Form W-2, and subject to Federal income tax withholding and employment taxes when paid.

A very common type of non-accountable plan is giving an employee a flat dollar amount as an “Auto Allowance” for business use of their personal auto.  If they are not required to substantiate the business miles and repay any excess back to the employer, this amount is taxable compensation.