The IRS issued an interesting Revenue Ruling recently that
describes both how to and how not to design an accountable
pln to absorb employee business expenses.
As we all know, expenses an employee pays personally are
only deductible to the extent they exceed 2% of adjusted
gross income and is not allowed at all for AMT purposes.
However, if the employer pays the expenses, they are not
included in the employee's income, no payroll taxes are due
and likely the employer gets a full tax deduction for the
payment. However, if an employer *reimburses* the employee
for expenses incurred, they may only be excluded if they are
reimbursed under an accountable plan that meets the
requirements of IRC Section 62(c).
An employee also cannot have the "option" of taking a
payment as salary or reimbursement--only in the area of
Section 125 plans and the various elective salary deferrals
can employees "convert" salary into nontaxable benefits "on
the fly" at their own discretion (the IRS has ruled there
are various cases where an employee, before a year begins,
may have such an option for certain other benefits, but
we'll ignore that here ).
Of course, what the employee and employer would love to be
able to do is take a portion of the employee's salary that
is paid as salary, and convert that to be treated as a
reimbursement under Section 62(c) once that reimbursed
amount is known. In that case, the employer would not have
to pay payroll taxes and the employee would avoid the
problems of employee business expenses.
Revenue Ruling 2004-1 shows both how to get awfully close to
that result--and also shows how to foul it up.
Both cases involve payments to courier employees who have
their own vehicles. In case 1, an employee is paid both a
base commission of one rate, and a mileage reimbursement
commission of another rate. The employer has set the
mileage reimbursement commission based on the employer's
recent history of actual mileage expense incurred by
couriers on jobs. The employees must report the actual
mileage back to the employer on a monthly basis, and if the
employee has been compensated in excess of the IRS mileage
allowance for his actual miles, that amount is added back to
the employee's taxable income and payroll taxes are paid.
In case 2, the employee is paid a flat rate Y. At the end
of the month, the employee again reports actual mileage to
the employer. The employer then subtracts the mileage rate
from the commissions paid, and treats that as a reimbursement.
The IRS rules that case 1 *IS* an accountable plan and that
the lessor of the reimbursement paid under the plan or the
actual mileage times the IRS rate can be excluded from the
employee's income. However, case 2 is *NOT* an accountable
plan, and all amounts must be included in income, payroll
taxes paid, and the employee has to claim the miscellaneous
The ruling can be read at:
Why this result? Well, the key factors appear to be that in
case 1 the employer set a maximum reimbursement ahead of
time and that rate was based on realistic and measured
expectations based on actual past results. Case 2 is a
problem because it is an attempt to reclassify something
that was paid as wages into excludable amounts *after* the fact.
This ruling is useful, though, because it tells us that a
plan *can* be designed to allow for the expected allocated
of payments to an accountable plan. It also shows that the
IRS does have limits as well, and they expect employers to
pay attention to those limits.
Ed Zollars, CPA
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