Prior to the Tax Cuts and Jobs Act, which went into effect January 1, 2018, unreimbursed work-related expenses were generally deductible on an employee’s individual tax return as a miscellaneous itemized deduction (Schedule A) if they exceeded 2% of an individual’s AGI. Starting in 2018, these deductions will be eliminated for tax years through 2025. This includes unreimbursed job-related expenses such as:
Instead, businesses can claim a deduction for employee reimbursements and those reimbursements are excluded from the employee’s taxable income — provided that the expenses are legitimate business expenses and the reimbursements comply with IRS rules. For changes in the deduction amounts businesses can take for meals, entertainment, and travel, read this blog post.
IRS compliance can be accomplished by using either an accountable plan or the per diem method.
An accountable plan is a formal arrangement to advance, reimburse or provide allowances for business expenses. Commonly this is accomplished through the use of expense reports and submission of employee receipts for reimbursement. To qualify as “accountable,” your plan must meet the following criteria:
If you fail to meet these conditions, the IRS will treat your plan as nonaccountable, transforming all reimbursements into wages taxable to the employee, subject to income taxes (employee) and employment taxes (employer and employee).
Saving receipts for all activities is just one piece of good documentation. However, this must be substantiated with what is known as the 5 Ws – who, what, when, where, and why. Along with each receipt, employees should document the the following on an expense report - (click here for a sample):
In the case of out-of-town travel the employer can also use the per diem method. Instead of tracking each individual’s actual expenses, you use IRS tables to determine reimbursements for lodging, meals and incidental expenses, or just for meals and incidental expenses. (If you don’t go with the per diem method for lodging, you’ll need receipts to substantiate those expenses.)
The IRS per diem tables list localities here and abroad. They reflect seasonal cost variations as well as the varying costs of the locales themselves — so London’s rates will be higher than Little Rock’s. An even simpler option is to apply the “high-low” per diem method within the continental United States to reimburse employees up to $282 a day for high-cost localities and $189 for other localities.
You must be extremely careful to pay employees no more than the appropriate per diem amount. The IRS imposes heavy penalties on businesses that routinely fail to do so.
Employers should keep in mind that employees will no longer be able to deduct work-related expenses on their 2018 tax returns. To avoid surprises at the end of the year, it will be important to have a reimbursement policy in place and reimburse throughout the year. Whether you have questions about which reimbursement option is right for your business or the additional rules and limits that apply to each, contact us. We’d be happy to help.