With salaries on a plateau or rising only slightly at most not-for-profit organizations, employers should be alert to other ways to give their employees a financial break. Having an accountable plan for business expense reimbursement is one way to save your employees some money.
Setting Up a Plan
A not-for-profit (or other employer) can’t reimburse employees for their business expenses tax-free just because the employees submit expense records. If the not-for-profit also has a properly executed accountable plan in place, it need not report qualifying reimbursed expenses as earnings on the employees’ W-2 forms. Thus, the employees won’t be taxed on the reimbursed amounts.
While the accountable plan isn’t required to be in writing, a formally established plan makes it easier for the not-for-profit to prove its validity to the IRS if ever challenged. A written plan also gives the organization a structure for describing its requirements for expense reimbursement.
The IRS stipulates that all expenses covered in the accountable plan have a business connection and be “reasonable.” This begs the question “What isn’t reasonable?” Let’s say an organization reimburses an employee at 80 cents per mile, rather than the 54.5 cents per mile allowed by the IRS in 2018 (53.5 cents in 2017). The IRS would consider the extra 25.5 cents excessive and treat it as taxable income.
- An employer can’t reimburse the employee more than what he or she paid for any business expense.
- The IRS requires that the employee account to an employer for his or her expenses and return any excess allowance within a reasonable period of time.
Following Reimbursement Rules
If an expense could otherwise qualify as a business deduction for an employee, it generally can qualify as a tax-free reimbursement under an accountable plan. For meals and entertainment, the plan may reimburse expenses at 100% that would be deductible by the employee at only 50%.
You must identify the reimbursement or expense payment and keep these amounts separate from other amounts, such as wages. The accountable plan must reimburse expenses in addition to an employee’s regular compensation. No matter how informal your nonprofit, you can’t substitute tax-free reimbursements for compensation employees otherwise would have received.
Assume, for example, that an employee receives $250 for a day’s work — whether traveling or not — and on a business trip incurs $75 in reimbursable expenses. You can’t treat $75 as tax-free reimbursement and report $175 as taxable income.
If you give your employees an advance for expenses and the funds aren’t used for qualified expenses, they’ll be considered to have been reimbursements under a nonaccountable plan and be taxable to the employee.
Accounting for Expenses
The IRS requires that the employer keep the following information for business expenses that are reimbursed:
- The amount of the expense and the date.
- The place of the travel, meal or transportation.
- The business purpose of the expense.
- The business relationship of the people entertained or fed.
Credit card statements may be used to provide key elements of documentation, such as the place and date of the expense, and employees must supplement the statement with documentation of other elements, which can be provided on a standard expense reporting form.
Require employees to submit receipts for any other expenses of $75 or more and for all lodging, unless your nonprofit uses a per diem plan. Such a plan can be used for lodging, meals and incidental expenses only when your employees are away from home on business.
The IRS has set standard per day amounts that taxpayers may use in lieu of actual amounts spent for meal expenses incurred while away from home on business travel. U.S. rates are available in IRS Publication 1542, Per Diem Rates, which also includes the IRS per day amounts for combined meal and lodging expenses. When using a per diem for travel — or mileage for vehicle usage — an employer may adopt a lower amount than the IRS maximum.
Speaking of mileage, employees need to keep track of that, too. An account book, diary, log, trip sheet or similar record may be used to substantiate a vehicle’s business use. This is the best way for employees to maximize and protect this deduction. Keep in mind that commuting mileage generally doesn’t qualify.
IRS Publication 463, Travel, Entertainment, Gift, and Car Expenses, provides more details on this topic.
Enjoy Full Tax Benefits
An accountable plan allows you and your employees to enjoy full tax benefits. If you don’t have a plan in place, your CPA can assist you in setting one up that will hold up to IRS scrutiny.