Ever heard of an accountable plan for expense reimbursements?
It could be a game-changer for your S-Corporation. In today’s post, I’ll explain how an accountable plan can help S-Corp owners save big on taxes.
What Is an Accountable Plan?
An accountable plan is basically a reimbursement agreement that is set up by an employer and is used to pay back employees for business-related expenses. These expenses can include things like supplies, mileage, auto expenses, cell phone, training, subscriptions, and internet. They can also include equipment that employees purchase for business purposes or even a home office.
Even if some of these expenses are mixed-use, meaning that they are used sometimes by the employee for personal use and sometimes for business purposes, they can still be reimbursed through an accountable plan.
If you’re an S-Corporation owner, you play the role of employer/shareholder and employee. This means that you can be reimbursed for your employee expenses as well.
How Does an Accountable Plan Work?
The beauty of an accountable plan is that these reimbursements are not considered taxable income for the employee, so the employee doesn’t pay income taxes on those amounts. And they are fully deductible for the employer, which means your S-Corporation doesn’t pay payroll taxes on the reimbursements either. In other words: it’s a win-win!
Without an accountable plan: S-Corp owners who pay for business expenses using their own personal funds and then reimburse themselves with the business’ money later would owe personal income tax on that amount.
With an accountable plan: The S-Corp will classify those expenses as reimbursements so that the owner wouldn’t have to pay taxes for that amount on their individual income tax return.
In terms of the actual payment, the easiest way to reimburse employee expenses is through a single check or deposit that comes from the business’ account and goes into the employee’s personal bank account. This is the preferred process I recommend to my clients.
However, if reimbursements are first recorded in your books as shareholder distributions, they can be recategorized later. It just makes things a little messier.
What are the requirements for an accountable plan?
The IRS doesn’t require you to have a written accountable plan. However, I highly recommend that you do.
Whether or not you put your accountable plan in writing, the IRS does have 3 specific requirements for your plan:
Requirement #1: Business Connection
To meet this requirement the expenses must have a direct business connection. This means that the expenses need to have been incurred while performing services as an employee of the S-Corporation.
For mixed-use expenses, it’s important that you include language in your accountable plan about what is considered business use and therefore can be reimbursed.
Requirement #2: Substantiation
For this requirement, the employee must substantiate the expenses by providing a detailed accounting of expenses. This can easily be done through receipts, invoices, or credit card statements that clearly show how much, when, and where the money was spent. Notating why the expense was needed can also be helpful.
Additionally, if the expenses are for meals, gifts, or property that is used for both business and personal purposes, then there are additional substantiation rules that may kick in. Be sure to speak to an accountant if your accountable plan will include reimbursements for these particular types of expenses.
Also, the employee should submit their substantiation documentation within a reasonable amount of time. The IRS suggests that the paperwork be submitted to the employer within 60 days of the expense being incurred.
Requirement #3: Return of Excess
Most employers don’t reimburse their employees’ expenses until after the expenses have been incurred. However, there are some employers that give the employee an advance reimbursement to cover expenses. If this happens, then the employee is responsible for returning the unspent money within a reasonable timeframe. Generally, the IRS wants that done within 120 days of the expense being incurred.
What are the tax advantages of an accountable plan for an S-Corporation?
Ok, here’s where things get exciting! The first way that an accountable plan can save your S-Corporation tax money is by helping avoid payroll taxes.
Normally, any expense reimbursements made to employees are considered taxable income. This means that these reimbursements would be included on your employees’ Form W-2s and your S-Corp would be responsible for paying payroll taxes (Social Security and Medicare taxes) on the reimbursement amount.
However, if you have an accountable plan, those reimbursements are not considered taxable income for the employee or the employer. Not having to cough up payroll taxes on those reimbursement amounts can add up to a huge amount of payroll tax savings, especially if your business has lots of reimbursable expenses.
Additionally, if your S-Corp has an accountable plan in place, your business can deduct the reimbursed expenses on the business tax return. This means that your S-Corp can reduce its taxable income amount which reduces the amount of income taxes you’ll need to pay.
Let me give you an example:
Lindsay, a sole proprietor photographer, decides to incorporate her business as an S-Corporation. To streamline expense management, she implements a detailed expense policy outlining eligible reimbursements. Over the past year, her S-Corp reimbursed her $30,000 for expenses related to business-use of her personal cell phone, home office, and mileage.
By incorporating and using an accountable plan, Lindsay can effectively manage business expenses. The $30,000 in reimbursements helps offset the costs she would have incurred for these business-related items. Additionally, these expenses can reduce the S-Corporation’s taxable income, which ultimately impacts her personal tax return. This approach can help optimize her overall tax situation.
Note: The specific tax benefits will depend on Lindsay’s overall income, deductions, and tax bracket. Consulting with a tax professional can provide tailored advice based on her unique financial situation.
How do I make an accountable plan?
Like I said, I recommend that your accountable plan be an actual document that you create so that everything is outlined clearly for you, your employees, and the IRS.
Writing the plan down also gives you an opportunity to think through the process you will use and tailor it to your business. I also suggest working with an accountant to not only cross all of your t’s and dot all of your i’s but to also reduce your risks should an audit occur.
However, you can get started on an accountable plan without an accountant. Here are the steps you can take so that your accountable plan can hold up to the scrutiny of the IRS:
Step #1: Write Your Plan
Make sure your plan includes the following details:
- Types of expenses that will be reimbursed (remember it has to have a business connection)
- Timeline for submitting expense documentation
- Types of expense documentation that are acceptable
- What should be included in expense documentation (how much, when, where, why)
- Timeline for the S-Corp to approve the expense
- Timeline for the S-Corp to reimburse the expense
- Timeline for the employee to refund any excess advance
Step #2: Communicate with Your Employees
If you have employees, make sure they understand the requirements of your business’ accountable plan. They need to know what documentation they are required to submit, the importance of submitting the document in the timeline provided in the plan, as well as how and when they need to return any excess advances.
Step #3: Implement a Reimbursement Procedure
Even if you only have a couple of employees, it’s smart to make sure you have a procedure in place for your business to review and approve expense reimbursements. You may use accounting software or a simple spreadsheet to keep track of your expenses, but no matter the tool you choose, make sure everyone understands the procedure and it’s clearly outlined in your accountable plan.
Step #4: Keep Detailed Records
Again, it’s so important to keep all receipts, invoices, statements, and records organized and up-to-date. If you work with an accountant, they can help you come up with a system for doing this.
Abridged by Amy
An accountable plan might seem like an unnecessary layer of paperwork or another tax hoop to jump through, but the tax savings can be well worth your effort, especially if you’re an S-Corp owner. Why leave money on the table – or put it in the government’s pocket – if you don’t have to?
If you need help setting up an accountable plan or understanding how or when an accountable plan can work for you and your business, be sure to reach out to an accountant with experience in helping small business owners take control of their taxes and finances.
While you’re here, some of my other free blog posts for S-Corp owners might interest you:
