Expense accounts, also called expense allowances, are plans under which companies reimburse employees for business-related expenses. These expenses include travel, entertainment, gifts, and other expenses related to the employer's business activity. Of particular interest to businesses and their employees is the tax treatment of business-related expenses, what types of expenses an employer will allow to be reimbursed, and how those reimbursements are administered.
For tax purposes a company's expense account plan is either accountable or nonaccountable. An accountable plan must meet the following requirements of the Internal Revenue Service (IRS): there must be a business connection, expenses must be substantiated, and any amount received by an employee in excess of actual expenses must be returned to the employer. Substantiation means that the employer must be able to identify the specific nature of each expense and determine that the expense was business-related. Expenses may not be aggregated into broad categories, and they may not be reported using vague terminology.
If the company's plan is in fact an accountable plan, then all money received by an employee under the plan is excluded from the employee' s gross income. It is not reported as wages or other compensation, and it is exempt from withholding.
Companies that fail to require employees to substantiate their expenses or allow employees to retain amounts in excess of substantiated expenses are considered by the IRS to have nonaccountable plans. Funds that employees receive under nonaccountable plans are treated as income, subject to withholding, and such expenses are deductible by the employee only as a miscellaneous itemized deduction (which must exceed 2 percent of the employee's adjusted gross income).
The tax laws affecting business-related expenses change from time to time. Starting in 1994, for example, allowable meal expenses were reduced from 80 percent to 50 percent. Other types of business-related expenses affected by changing tax laws include deductions for spousal business travel and for dues and memberships in certain types of clubs.
Employees who find they are incurring business-related expenses need to determine from their employer exactly what types of expenses are reimbursable. In an effort to control spiraling travel and other business-related expenses, some companies have developed reimbursement policies that spell out in detail what expenses qualify for reimbursement. For example, companies may require employees to book their travel in a certain way or from certain vendors.
Because of the IRS's substantiation requirement, employees need to carefully document all business-related expenses. To reduce the paperwork burden on businesses, the IRS starting in 1962 directed businesses to save receipts for all expenses over $25. Effective October 1, 1995, the IRS raised the minimum amount to $75. Nevertheless, many tax advisors warned that it would be wise to keep receipts for all expenses in order to provide adequate documentation in case of an IRS audit. If it is not possible to obtain a receipt, the amount of the expense should be noted along with the date, place, and reason for the expense.
In the future it may become easier for businesses and employees to keep track of business expenses using Internet -based programs. The Extensity Expense Reporter, published by Extensity Inc., is one such program introduced in 1998 that allows users to file their expenses using an Internet connection. Credit card bills can be automatically incorporated into the expense reports. The program passes on the expenses to a manager within the company and directs payments. It even notes irregularities and records excuses given by employees for subsequent review.
[ David P. Bianco ]
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