There’s no doubt that in order to make money, you need to spend money. However, when it comes to taxation, the way that companies choose to spend their money can make a huge difference. Depending on how a company structures their work-related expenses will affect not only how the company is taxed on those expenses, but how employees are reimbursed for the money they spend.
Companies that give employees allowances for work-related expenses use plans that are called expense accounts. Any expense related to travel, entertainment, gifts, meals, etc. that are for business purposes are considered to fall within the scope of an expense account. The IRS divides expense accounts into two categories: accountable and non-accountable.
Accountable Expense Accounts
In order to meet the IRS’ requirements for an accountable plan, the following must be true:
- Purchases must be business-related
- There must be an itemized account of the expenses in order to substantiate them
- If an employee receives more money than winds up being spent, the excess must be returned to the employer
Keeping clear documentation of all expenses made from an accountable expense account is of the utmost importance. The employer needs to be able to identify where every purchase was made, and for what expense the money was spent, in order to determine whether or not it was work-related. Additionally, expenses can’t be combined into broad categories—they need to be specifically itemized.
When using accountable expense accounts, employees are not required to include the money they’ve spent in their gross income when they file taxes. The funds are not reported as wage or other compensation, and are also exempt from withholding.
Non-accountable Expense Accounts
If employees aren’t made to substantiate their expenses, or they’re allowed to keep excess of what’s spent, the IRS considers their plans “non-accountable.” Under non-accountable expense account plans, funds received by employees are treated as income, and are subject to withholding. The amount received can only be deducted as miscellaneous itemized deductions, and can only be deductible if it exceeds 2% of the employee’s adjusted gross income.
Tax laws regarding business-related expenses change often—sometimes annually. There are many factors that affect how tax laws are changed, such as legislation, the economy, and corporate scandals. For example, in the wake of the highly publicized scandals at Enron and WorldCom, the Sarbanes-Oxley Act of 2002 was created, which requires much closer tracking and record-keeping for publicly traded companies. While most small businesses remain unaffected by legislative changes regarding large corporations, per diem rates (daily allowances) permitted by the IRS become something that all companies need to keep in mind, regardless of their sizes.
How do account policies affect small businesses specifically? Check back with us next week for the answers!