We're here to talk about using an accountable plan to create tax free reimbursements and you might be wondering what is an accountable plan.
An accountable plan is a policy, ideally written, on how you're going to actually get paid for reimbursing expenses through your business legally and how to create a tax deduction from it.
Here's what you need to know about what an accountable plan is
An accountable plan allows employees to be reimbursed for expenses paid out of pocket.
For example, when you don't have an LLC or you do, and you're just a single member and you've not elected to be treated as a corporation, you're an owner. When you have an LLC that's elected to be taxed as an S Corp, or you are an S Corp or a C Corp as a corporation, you're a shareholder. So when you're filing a Schedule C on your tax return, and you're a single member, LLC, husband and wife, LLC, that's not elected to be treated differently for tax purposes, or you're just a person out there in the world trying to do their thing without an LLC then you are an owner.
When you have a corporation, you are a shareholder. It's very important to draw the distinction between how you're defined in those two kinds of entity conversations. When you're a shareholder, you are most likely also an employee as a result of either being an owner or a shareholder employee, you need to have a way or a vehicle to be reimbursed for expenses that are paid out of pocket by you.
There should technically be some expenses that are paid out of pocket by you and those expenses through the accountable plan become deductions to the business and the employee or employee, owner, or employee shareholder can be reimbursed for those, which is essentially non-taxable cash flow to you personally.
Why should I consider having an accountable plan?
An accountable plan is one of the ways that you can keep some of that money you're making and it be a tax deductible expense. This is why you should consider one, because if you do not have an accountable plan, the payments to the employees or yourself could be considered additional wages.
What that means is you could be paying more tax than you need to be paying because they're considered net wages. Common examples of expenses that can be reimbursed through an accountable plan, include your mileage, auto expenses, other travel expenses outside of business designated travel expenses, business meals, meals that have been enjoyed for the purpose of promoting or building the business and mileage. A mileage log can be used to track everything, or you can use an app to track mileage. You would then file an expense report to the business, to reimburse you for those miles through the accountable plan.
What entity types can benefit from having an accountable plan?
These are the types of entities that can benefit from an accountable plan.
- If you file a schedule C on your 1040,
- If you file a schedule F on your 1040,
- If you have a farm rental entity,
- If you have an S Corp, meaning you file an 1120S by March 15th of each year,
- If you have a C Corp, which is an 1120 that you file by April 15th of each year, or
- If you are in a partnership
Are there any type of assumptions that are made?
The assumptions are that the expenses that are being reimbursed to you have not been previously used as a deduction elsewhere.
So for example, let's say that in your small business, you go out and you have a business meal to talk to someone about your business to promote it. Let's say you decide that you're actually gonna just pay for that meal with the business credit card or the business debit card. That is already in the business and it's going to be expensed as such.
You cannot then turn around and take that receipt for that business meal and then file an expense report for you to be reimbursed again for the same meal that the business already got covered. That would be double dipping. So you would not want to do that.
When it comes to meals, the best practice would ideally be that you pay for any meals outside of your business, using your personal credit or debit card, you don't have to. This is just a best practice situation, because it certainly adds steps to the process.
Once a month or once a quarter, you would want to file an expense report through the business to get reimbursed for all those out of pocket expenses that you paid for. They need to be expenses that the business can actually reimburse you for and claim as a deduction.
You just have to really watch when you are doing these types of expenses on company debit or credit cards, like you still have a responsibility to make sure the documentation is being taken care of and being properly done. And what is really nice about this way is that it is really easy. If a person has a lot of meals, it may look like they just lived out of their business and called everything a meal. The question is, did they go through the process and through the policy to well document their business meals?
What are the requirements to add an accountable plan?
There are actually three rules that need to be met when it comes to having an accountable plan in place.
- Your expenses have to have a business purpose. So, this is not for any other type of expense reimbursements other than they have to have a business purpose. It's kind of like if somebody were to ask a question around, can my business have a company vehicle? One of the things we always say is, it has to have been used for the business at least 50% of the time in order to be a business or company vehicle. So you have to have that business connection.
- Proper documentation. Use some kind of expense statement or log with receipts to support any expenses over $75 to the employer or the business for the expenses in a reasonable period of time. Your accountable plan is going to establish what is reasonable and that is important. Try to not go longer than once a quarter, having the business reimburse you. There are plenty of times where we have worked in situations where, because the business owner didn't realize they could do this, they didn't have the proper processes set up. It's easy to procrastinate when it comes to finances, especially in your small business. I would say once a year is really pushing it and once a quarter is more ideal. We would want to see you at least looking at your numbers and getting reimbursed for things at least once a quarter. The best scenario is that you're doing it within 30 days of the expense. That way you will also see some consistency around how you're spending your money. Reasonable is subjective and your accountable plan being put together in writing can really help you determine what is reasonable as a policy.
- Employees must return any excess reimbursements to the employer within a reasonable time. There's kind of this language out there called per diem. And I don’t want to get into it too much, but this really happens in this type of scenario. Let's just say that you're gonna go on a trip to some kind of show to learn about how to sell your shirts. Let's just say you're gonna pull $500 out for expenses, but let's say you only spend $300 for those expenses. You put it in your personal bank account to pay for things, but you only spent $300, then you need to put the $200 back that you didn't spend. That's what your accountable plan is telling you. They have to have a business purpose. You have to have a report and receipts to back up the expense. And if you end up getting in advance more than what the expenses actually were, you gotta put that money back into the company. This is why it's really important that your accountable plan should be put in writing, because this isn't just for you, but anybody that becomes involved in your business.
Pros
There are plenty but these are the big two. Reduced taxable income and self-employment tax for the owner or the shareholder.
This is one of the biggest reasons why you want an accountable plan in place. It also allows the reimbursements to be excluded from taxable income.
Cons
It is very exciting to know that you can have a structure that's gonna create rewards and returns for your money. It is very exciting to know that you can create tax free income for yourself.
Like for me, from my perspective, that's very exciting but there are a couple of cons as well. Such as keeping track of the paperwork and policy tracking. I think personality has a big play on whether or not you see it as a con.
Is this really worth it?
Yes. I'm never gonna tell you, it's always a yes. Yes, we have to outweigh the cost of administration and the burden that it may impose on us. But if you have a great process, and if you have an executive assistant, which I hope if you're just yourself, at some point when your business can afford it, you're at least getting an executive assistant. This is something you can definitely delegate as long as you have the process and the policy and structure in place.
Is it legal?
It's absolutely legal to do an accountable plan and to be reimbursed for business expenses through your business that you pay for out of your pocket.
There is some fancy RF code that we have and publications that have been produced, but there's no strategy that we ever talk about that we can't support through code, publications or case studies. So it's absolutely legal. We want to walk the line, we don't want to cross the line with our strategies and it's not enough for someone to tell you it's legal. It's really important as a business owner and a taxpayer that you understand too. But the short answer in a long response is yes.
What about meal deductions?
This is a great time to remind our readers that when you have an accountable plan and you reimburse things through an accountable plan, it's kind of like going back to that conversation that you cannot use an accountable plan as a strategy.
If you have already put strategies in place through the business, you cannot double dip. This is very important, and I'll use the meals as an example. I told you that you cannot have the business pay for the meal and then use the receipt to reimburse you for the meal.
When it comes to meals, especially in 2021 and 2022, when the Cares Act got put in place in 2020, it created this exception for the 50% deductibility limit on meals. When you did meals prior to 2021, It was a 50% tax deduction. The business could pay a hundred percent of the meal, but only 50% of the meal was deductible. And in 2021, because of everything, basically meals are 100% deductible right now. So that is the government's way of supporting the hospitality industry that got hit so hard during all the things we dealt with through the pandemic.
The language is also clear that a meal does not have to be eaten on the restaurant's premises. So they open the door for to-go, and take out delivery of meals. They are, at the time of writing this, fully deductible at 100%. There are some caveats to that, but for the most part, take advantage of those meal deductions and use your accountability plan to do it.
How does having a home office work with an accountability plan?
First of all, I want to say, do not be afraid of having a home office deduction or a home office expense.
If you have a business that is not a schedule C meaning you're an S Corp, an LLC taxed as an S Corp, a C Corp, or a partnership, you can actually create your accountable plan to reimburse you for your home office expenses.
This is how you decide what the angle expenses of your home are. Just very simply put. We are going to talk about this in more detail in a future episode, because I get a lot of questions around this, and we get people who get super anxious about home office deductions and home office expense reimbursements. There is a lot of stuff out there from the past.
This could increase your likelihood of an audit and you do not want to be too aggressive here. There are a lot of things out there to scare you away from doing this. I just want people to know that you don't have to be scared. You just have to understand. The reason why you have to understand is that if you're ever audited, you have to explain what you did and how you did it and why you felt like you could do it.
So, when it comes to reimbursing the home office expense, it's basically you understanding what the annual cost of operating your home was for that year, taking the square footage of the space that you use for exclusive business purposes and then basically figuring out what the percentage of that space is to your total household square footage.
So let's just say it's 10% and your annual expenses for your household is $10,000. Basically, you would be able to get the business to reimburse you 10% of that through the accountable plan.
Again, this is for a business that is not a scheduled C business owner. This is for a corporation or a partnership using their accountable plan to be reimbursed for their home office. Not the home office deduction. I want to be super clear about that.
What some people will do is figure out the annual cost of their home as an average, but it has to be based on actual expenses, because they want to reimburse themselves each month through their accountable plan or once a quarter.
Then, at the end of the year is when you know what the real number is for what you spent for that year. If you find that you have actually been paid more, then you should have been paid throughout the year for your home office expense reimbursement. You have 120 days to basically get that money back into the business that was in excess of what you should actually deduct.
That's the main thing I want everyone to understand while reading this, do not code this as rent. Rent is technically income to you personally. So if you push that home office expense as reimbursement to rent, you are going to have to get a 1099 at the end of the year from the business. You will then have to treat it as income on your personal tax return.
So you do not want to do that. What you want to do is call it office expenses, office supplies, or office space. You want to do something that makes it very clear that it is not rent because it is an expense, it is a reimbursement for your home office expenses through your accountable plan.
If you want to learn more about an accountable plan, check out Episode 095: Using An Accountable Plan To Create Tax-Free Reimbursements.
