accountable plans
How to Reimburse Employees for Business Use of Their Cars
Many employees use their personal vehicles for company business, and many businesses reimburse employees for auto expenses the employees incur while on company business. If done the right way, employers receive a tax deduction for the reimbursement, and the reimbursement is tax-free to the employee.
Employers can reimburse the actual auto expenses of employees under an accountable plan to be subject to the favorable tax rules above. Instead of reimbursing actual auto expenses, employers may also reimburse employees through a mileage allowance regardless of the actual amount spent for auto expenses and still be subject to the favorable tax rules above.
Reimbursing Employees With a Mileage Allowance
A mileage allowance is an allowance paid under an accountable plan that meets the following requirements:
- the allowance is paid for ordinary and necessary business expenses incurred by an employee for auto expenses in connection with the performance of services for the employer
- the allowance is paid at the applicable business standard mileage rate, under a flat rate, or stated schedule, or in accordance with any other IRS-specified rate or schedule
Employers may reimburse an employee at a higher rate than the standard mileage rate of 57½ cents (for 2015) if the reimbursement rate is reasonably calculated not to exceed the amount of expenses incurred by the employee. However, only the portion of the reimbursement rate equal to the standard mileage rate is treated as under an accountable plan and qualifies for the favorable tax treatment.
Example:
ABC Corp reimburses its employee, John, at a rate of 60 cents per mile even though the standard mileage rate is 57½ cents per mile. John drives 300 miles on employer business. The tax treatment is as follows:
Total reimbursement $180.00 (60 cents times 300 miles)
Reimbursement at Standard Mileage Rate $172.50 (57½ cents times 300 miles)
Excess Reimbursement $7.50
The $172.50 reimbursement is deducted by ABC Corp and is tax-free to John. The $7.50 excess reimbursement is deducted as payroll by ABC Corp and is taxable income to John. The excess reimbursement is subject to payroll taxes to ABC Corp and is subject to FICA tax to John.
Advantages of Using a Mileage Allowance
Reimbursing an employee under a mileage allowance has the following benefits over reimbursing actual expenses:
- Reduced substantiation: mileage allowances eliminate the need for employees to gather documentation supporting the amount spent for automobile expenses. While employees don’t have to substantiate the amount of auto expenses, they must still substantiate the other elements of the auto expenses such as dates, locations, miles, and business purposes of the trips.
- Retaining excess reimbursements: if the mileage allowance at the standard mileage rate exceeds the actual expenses of the employee, the employee may keep the excess reimbursement tax-free. Normally, excess reimbursements under an accountable plan must be returned to the employer.
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Buzzkill Disclaimer: This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.
The Right Way and The Wrong Way to Reimburse Employees
When a business reimburses an employee for incurring business expenses, there is a right way and a wrong way to do so. The right way is through what is known as an accountable plan. The wrong way is through…wait for it…a nonaccountable plan.
The Wrong Way
If the employer has a nonaccountable plan, when the employer reimburses an employee for business expenses the employer takes a deduction in the amount of the reimbursements. The deduction is treated as a compensation deduction and the reimbursement is included in the employee’s income. Payroll taxes on this amount are due. If the employee has substantiation for the expenses, she can deduct them as an itemized deduction on her personal tax return. These expenses are reported on Form 2106, and are subject to the 2% of AGI floor. Additionally, if the employee had meal expenses, she can only deduct 50% of them.
Example: JoJo Corp employs John and JoJo Corp does not have an accountable plan. John incurs business expenses of $1,000 for travel and supplies and $500 for meals. JoJo Corp reimburses $1,500 of John’s expenses. JoJo Corp takes a $1,500 deduction (JoJo Corp’s deduction for meals is not reduced by 50%). JoJo Corp pays FICA, FUTA, and state unemployment tax on this $1,500 compensation deduction. John’s W-2 is increased by the $1,500 reimbursement. John will also pay his share of FICA tax. John can take an itemized deduction for $1,000 of the travel and supplies expenses and an itemized deduction of $250 for the deductible 50% of meal expenses. However, these expenses are reduced by 2% of Jon’s AGI. If John has AGI of $100,000, the $1,250 deduction is reduced by $2,000 (2% of $100,000 AGI). Since the deductions are less than 2% of AGI, John cannot take a deduction.
The Right Way
If the employer has an accountable plan, expense reimbursements are deductible by the employer as business expenses rather than as compensation. The 50% meal limitation now applies to the employer. The reimbursements are excluded from the employee’s income and are exempt from payroll tax.
Example: Same facts as above, except JoJo Corp has an accountable plan. JoJo Corp will have a business deduction of $1,250 ($1,000 for travel and supplies plus 50% of the $500 meal expense). John will not have to report the amount of the reimbursement as income. Neither JoJo Corp nor John will owe any payroll taxes on the reimbursement. Since JoJo Corp takes the deduction for the business expenses, the 2% of AGI floor is irrelevant.
There are three requirements of an accountable plan:
PROVING A BUSINESS CONNECTION
The plan pays reimbursement and allowances only for otherwise deductible business expenses (such as travel, lodging, or meal expenses)
MAINTAINING ADEQUATE SUBSTANTIATION
The employee accounts for the business expenses by submitting to the company a detailed written record substantiating the expense’s time, place, amount, and business purpose.
REQUIRING EMPLOYEES TO RETURN EXCESS ADVANCES
This mainly applies when an employer advances funds to the employee to pay business expenses. Advances in excess of business expenses must be returned to the employer.
A few years back, the IRS had an audit initiative focused on executive compensation, fringe benefits, and employee reimbursement plans. IRS found a great deal of noncompliance and, in future audits will spend more time auditing these items. It is very important to properly comply with the three requirements of accountable plans if you want to take advantage of the benefits they offer.
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Buzzkill Disclaimer: This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.
Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230
