Employees of a business often incur expenses on behalf of the business. The best way for the business to reimburse such expenses is to use an accountable plan as described in Regulations Section 1.62-2. If the business uses an accountable plan, the reimbursements received by the employee are not included in the employee's gross income. Therefore, they do not appear on the employee's Form W-2. The reimbursement is not subject to income tax withholding or payroll taxes. The employee may not deduct the reimbursed expenses. The business deducts the expenses, except that the business may generally deduct only 50 percent of business meals and entertainment.

The employee may deduct any expenses not reimbursed as a miscellaneous itemized deduction, except that the employee may generally deduct only 50 percent of business meals and entertainment. The taxpayer must reduce total miscellaneous itemized deductions by two percent of adjusted gross income. In addition, itemized deductions generally do not provide a benefit to a taxpayer unless total itemized deductions exceed the standard deduction. Therefore, the employee may receive little, if any, tax savings from the deduction.

To qualify as an accountable plan, the employee must substantiate the expenses to the employer. The employee must document the time, place, business purpose, and amount of each expense. The employee must also return any unused advances within a reasonable time.

Some businesses use nonaccountable plans. They give each employee a certain amount that the employee may spend for business purposes. The employee may or may not be able to keep any excess depending on the plan.

While a nonaccountable plan has the advantage of simplicity, it has tax disadvantages for the employer and for the employee. Under this type of expense account arrangement, any amount the employer provides to the employee is taxable as compensation. This treatment means that the employee is subject to income tax withholding, Social Security tax, and Medicare tax on the expense account. In addition, the employer is subject to payroll taxes on the amount. The employee may deduct the actual expenses incurred, except that the employee may deduct only 50 percent of business meals and entertainment.

However, the employee may not receive any tax benefit from the deduction because employee business expenses are deductible only as a miscellaneous itemized deduction. The employee must subtract two percent of the adjusted gross income shown on the return from the total miscellaneous itemized deductions. Only the excess over this reduction is deductible. The employee's total itemized deductions must generally exceed the standard deduction to provide any tax benefit. In addition, miscellaneous itemized deductions are not allowed for purposes of calculating the alternative minimum tax.

The best way to handle employee business expenses is to establish an accountable plan that complies with the requirements of Regulations Section 1.62-2. The tax advantages of an accountable should be greater than any increased bookkeeping burden over a nonaccountable plan.

Alan D Campbell

Alan D Campbell holds CPA licenses in Florida and Arkansas. He is also a Certified Management Accountant and Certified Financial Planner certificant. He is also admitted to practice before the United States Tax Court. He has a Ph.D. in accounting from the University of North Texas with an emphasis in taxation.

He teaches an online class called "Finance and Accounting for the Nonfinancial Manager" for Villanova University in association with Bisk Education. He also advises the Business Environment and Concepts section of the Bisk CPA Review online for Bisk Education.

He is a co-author of the book Tax Strategies for the Self-Employed, which is published by CCH Incorporated. He is also the revision editor of CCH Financial and Estate Planning Guide, 15th edition. He has published articles on tax topics in The Tax Adviser, Taxes--The Tax Magazine, Taxation for Accountants, The CPA Journal, Tax Notes, Trusts & Estates, and The National Public Accountant.