Businesses can reimburse owners and employees for out-of-pocket expenses under an accountable plan, a set of rules and processes that allow tax-free reimbursements of certain business expenses. To qualify, an accountable plan must contain the following three terms and conditions:
- Employees must substantiate their expenses by providing the business with a written statement of expenses they paid, along with receipts and any other documents needed to prove the expense is legitimate. The documentation must show the amount paid and the business purpose for the expense. Employees also need to document the time and place of any travel or meal. For gifts given to clients or vendors, employees should also describe what was given and how the recipient of a gift is related to the business.
- The company can only reimburse employees for tax-deductible expenses related to the business. Expenses should be approved for reimbursement only if the expense relates to the business.
- The company must require employees to return any excess advances in a timely manner.
Your accountable plan should detail when employees need to provide you with substantiating documents and to return any funds paid out in advance that were not spent on legitimate business expenses.
The IRS provides two safe-harbor methods for preserving the advance as a tax-free reimbursement. We highlight just one method—the fixed date method—to illustrate what we mean by the time constraint. Using this method:
- The business advances funds only within 30 days of when the expense is paid;
- The employee requests reimbursement and provides substantiating documents within 60 days of paying the expense; and
- The employee returns any excess advances within 120 days after the expense is paid.
The best time to set up an accountable plan is now. We can advise you on how to set up expense reports and reimbursement processes that will pass IRS muster.