June 1999 Issue



By Jay A. Soled

IRC section 67 limits the deductibility of business-related expenses to the excess of two percent of the employee's adjusted gross income unless the expenses are incurred under an accountable reimbursement and other expense allowance plan.


The Treasury regulations promulgated under IRC section 62 set forth in detail three requirements that must be met in order for a plan to meet the definition of "accountable" as follows:

* Expenses Must Have a Business Connection. An arrangement meets this requirement if it provides advances, reimbursements, or allowances (including per diem allowances and allowances for meals, mileage, and incidental expenses) for allowable business expenses, and the business expenses are paid or incurred in connection with the performance of services as an employee of the employer.

* Expenses Must Be Substantiated. Each business expense must be substantiated in accordance with the rules provided under IRC section 274(d) or, alternatively, the employee must submit information to the employer sufficient to enable the employer to identify the specific nature of each expense and to conclude it is attributable to the employer's business activities.

* Employees Must Return Amounts in Excess of Expenses. An arrangement meets this requirement if it obligates the employee to return to the employer within a reasonable period of time (generally, within 120 days after an expense is paid or incurred) any amount paid under the arrangement in excess of the expenses substantiated.

The amounts paid pursuant to an accountable plan are excluded from the employee's gross income, are not reported as wages or other compensation on the employee's Form W-2 and, in addition, are exempt from withholding and payment of employment taxes.

If one or more of the three requirements specified above are not met, all amounts paid are treated as paid under a nonaccountable plan. If an employee fails to return in a reasonable period of time amounts paid in excess of the substantiated expenses under what would otherwise be an accountable plan, the amounts paid that are in excess of the substantiated expenses are treated as paid under a nonaccountable plan. Furthermore, if an employer's reimbursement or other expense arrangement evidences a pattern of abuse, even if it satisfies all three accountable plan requirements, all payments made under the arrangement will be treated as made under a nonaccountable plan.

If a plan is nonaccountable, the amounts paid pursuant to such a plan are included in the employee's gross income, must be reported as wages or other compensation on the employee's Form W-2, and are subject to withholding and payment of employment taxes when paid. Provided that they can meet the requisite substantiation requirement, employees that incur expenses under a nonaccountable plan may deduct such expenses as miscellaneous itemized deductions, subject to the limitations applicable to such expenses (e.g., the two-percent floor provided under IRC section 67).


The following six examples illustrate plans that, in one fashion or another, are flawed and therefore nonaccountable.

Example 1: The employer compensates employees by paying them a 40% commission on all delivery charges. For each pay period, the employer calculates the total commission due each employee. The commission paid is first allocated to pay the employee's minimum wage; the balance, if any, is paid to the employee to reimburse the employee for the employee's traveling expenses. Held, the employer's plan is nonaccountable because the employer's intent is to pay its employees the agreed-upon commission, the plan does not require substantiation, and the plan is not arranged in a manner to compensate employees for their bona fide traveling expenses [PLR 9504002 (January 27, 1995)].

Example 2: At the beginning of each calendar year, the employer allows each employee the right to reduce from zero to 40% the amount of gross commission payable to the employee for the upcoming year. In exchange for the reduction in commissions, the employer will pay the employee's business expenses for the calendar year up to a maximum equal to the amount by which the employee elected to reduce the employee's commissions. The employer would only pay for those expenses that are connected to its business and substantiated by the employee. Held, the reimbursements are made pursuant to a nonaccountable plan. This is because amounts paid under an accountable plan must be in addition to and not in lieu of salary [(PLR 9325023 (June 25, 1993)].

Example 3: The employer provides its employees with advance allowances to maintain their own trucks, used in connection with the employer's business. The employer determines the amount of the allowance by estimating what it costs its employees to operate the trucks based on the number of loads and types of services rendered by the trucks. Held, the allowance is not part of an accountable plan because the employer did not obtain adequate substantiation of employees' expenses and employees were not required to reimburse the employer for any allowance in excess of expenses [PLR 9317003 (April 30, 1993)].

Example 4: The employer maintains two different reimbursement plans, one for supervisors and the other for nonsupervisors. Under the former plan, supervisors are reimbursed at the rate of $X per day or the applicable cents-per-mile rate (as prescribed by the IRS), whichever is greater, and the integrity of the claim is the supervisor's responsibility. In contrast, under the latter plan, nonsupervisors are required to supply odometer readings for purposes of calculating reimbursable mileage and reimbursed at the applicable cents-per-mile rate. Held, the nonsupervisors plan is accountable and the supervisors plan is not. This is because the supervisors plan does not require supervisors to submit mileage records or return amounts in excess of substantiated expenses [PLR 9547001 (November 24, 1995)].

Example 5: The employer advances $1,000 to an employee for expenses that are not expected to exceed $400 in that quarter. Whenever the employee substantiates an expense, the employer provides an additional advance in an amount equal to the amount substantiated, thereby providing a continuing advance of $1,000. Because 1) the amounts advanced under this arrangement are not reasonably calculated so as not to exceed the amount of anticipated expenditures and 2) the advance of money is not made on a day within a reasonable period of the day that the anticipated expenditures are paid or incurred, the arrangement is part of a nonaccountable plan [Treas. Reg. section 1.62-2(j), example 5].

Example 6: The employer provides expense allowances to certain employees to cover their business expenses. In addition, the employer requires expense substantiation and return of any amount in excess of substantiated expenses. Each time an employee returns an excess amount to the employer, the employer pays the employee a "bonus" equal to the amount returned by the employee. Because of the so-called bonus arrangement, the plan fails to meet the third requirement of an accountable plan (i.e., return of allowance amounts in excess of expenses) [Treas. Reg. section 1.62-2(j), example 8].

Court Rulings

The courts have also offered their perspective on what constitutes an accountable plan. A commonly expressed theme is that intent alone is insufficient to render a plan accountable. All requirements of an accountable plan must be met.

Consider the status of the reimbursement plan the taxpayer instituted in Trucks, Inc. v. United States (987 F.Supp. 1475, N.D. Georgia 1997). The taxpayer was in the business of hauling commercial freight by truck. As part of its compensation arrangement with its employees, drivers were paid 14% of the "load revenue" generated by each trip as wages and a flat six percent of the load revenue as a per diem expense reimbursement. As reported by the court, "the expense reimbursement allowance was intended to cover the costs of meals, lodging, and other incidental travel expenses while [the drivers] were away from home."

The court ruled the plan to be nonaccountable because 1) the business connection requirement was not met--the employer reimbursed the employee a fixed sum as a business expense regardless of whether the employee incurred, or was reasonably expected to incur, the business expense, and 2) the substantiation requirement was not met because the taxpayer did not require that employees document their expenses.

Other courts, too, have exhibited little tolerance toward taxpayers for their failure to meet the necessary requirements of an accountable plan. In United States v. Armstrong [974 F. Supp. 528 (E.D. Virginia 1997)], reimbursement plans used by the taxpayer's employer were nonaccountable plans where the taxpayer had the right under the plan to retain the difference between reimbursement payments for airline tickets and the actual amount of travel expenses incurred. In O'Neil v. Comm'r [71 T.C.M. 2317 (1996)] a car allowance was reported on an employee's Form W-2 because it was paid pursuant to a nonaccountable plan.


The rules specified for accountable plans are exacting. They leave little room for creativity on the part of the accountant or client. That being the case, careful planning is in order. First, the format of the plan must conform to the IRC and the requirements specified under the applicable Treasury regulations. Second, the employer must institute the proper safeguards to ensure that, in practice, the rules of the plan are being followed. From a practical perspective, this means that the employer must be vigilant and demand that employees substantiate their expenses and return amounts in excess of substantiated expenses within a reasonable time.

Employers and their accountants should also recognize that if the plans they institute are nonaccountable, they are under a different set of compliance requirements. These requirements result in the employer bearing a larger employment and withholding tax burden and the employee bearing a larger income tax burden. *

Jay A. Soled is an assistant professor at Rutgers University.

Edwin B. Morris, CPA
Rosenberg, Neuwirth & Kuchner

Contributing Editor:
Richard M. Barth, CPA

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