If you are a small business owner, how do you ensure deductibility of business expenses you paid from personal funds? Depending on the circumstances, you may need what the IRS calls an “accountable plan”. This is an employee reimbursement plan that meets specific IRS-required criteria.
Employee or contractor
Business expenses paid by employees or contractors can be deducted if the employee or contractor is reimbursed. An accountable plan is needed to prevent reimbursement counting as income. For some expenses, such as moving expenses, reimbursement will count as income even with an accountable plan.
Owner of single member LLC (not taxed as S-Corp or C-Corp) or sole proprietor
Business expenses paid by the owner can be deducted whether paid from business funds or personal funds. Reimbursing personal funds is optional, but it does make it easier to track expenses within the company’s books. No need for an accountable plan.
Partner in partnership OR member of LLC with multiple members (not taxed as S-Corp or C-Corp)
Business expenses paid by a partner/member may be deductible. It depends on what’s written in the partnership agreement. This can get complicated and is beyond the scope of this article. However, even if partnership agreement calls for reimbursement of expenses, an accountable plan is not required for partners/members.
S-Corps and C-Corps
Business expenses paid by shareholders, employees or contractors can be deducted if the person is reimbursed. An accountable plan is needed to prevent reimbursement counting as income. For some expenses, such as moving expenses, reimbursement will count as income even with an accountable plan.
More info about accountable plans
As explained in IRS Publication 463, if a business’ reimbursement plan does not follow IRS requirements for an accountable plan, the plan is deemed non-accountable. In this case, reimbursement of expenses is considered part of the employee’s compensation and, therefore, is subject to withholding and must be reported on an employee’s W-2 form.
To qualify as an accountable plan, employees must:
- Have paid or incurred deductible expenses while performing services as an employee,
- Adequately account to the employer for these expenses within a reasonable period of time, and
- Return any excess reimbursement or allowance within a reasonable period of time.
What counts as a “reasonable period of time”? Facts and circumstances determine what is reasonable in a given situation. Actions that take place within the following list will be treated as taking place within a reasonable period of time.
- Any advances are provided within 30 days of the time the employee has an expense.
- The employee adequately accounts for the expense within 60 days after the expense was paid or incurred.
- The employee returns any excess reimbursement within 120 days after the expense was paid or incurred.
- The employer gives the employee a periodic statement, at least quarterly, that asks the employee to either return or adequately account for outstanding advances, and the employee complies within 120 days of the date of the statement.
Also, when an employee has a right to reimbursement for expenses related to his or her status as an employee but fails to claim reimbursement, the expenses are not deductible since they are not considered necessary expenses.
Once you have an accountable plan, be sure to do these things on a regular basis to help ensure deductibility of expenses:
- Prepare your expense reports and submit them to the company. The expense reports should be accompanied by receipts and other documentation substantiating the expense.
- Process the reimbursement request by paying yourself from the company account and then recording the expense on the company’s books.
For more information, see https://www.irs.gov/publications/p463 or consult a qualified tax advisor.