How to Set Up an IRS Accountable Plan

An IRS accountable plan provides a structured system for employers to reimburse employees for business expenses. This arrangement ensures that reimbursements are not considered taxable income to the employee, provided specific Internal Revenue Service (IRS) rules are met. Governed by Internal Revenue Code Section 62, this framework offers tax advantages for both parties by allowing employers to deduct reimbursed expenses as business expenditures, while employees receive tax-free compensation for out-of-pocket work-related costs.

Key Requirements for Accountable Plans

For a reimbursement arrangement to qualify as an accountable plan, it must satisfy three core IRS requirements. The first is the “business connection,” meaning expenses must have a clear business purpose and be incurred while the employee performs services for the employer. Personal expenses are not eligible for reimbursement, though the business portion of mixed-use expenses, like a personal vehicle used for work, can be reimbursed.

The second requirement is “adequate accounting” or “substantiation,” which mandates that employees provide sufficient documentation for their expenses within a reasonable period. This documentation must verify the amount, time, place, and business purpose of the expense. Receipts, invoices, or mileage logs are common forms of proof; for certain expenses like meals, attendee names and their business relationship are also necessary. The IRS generally considers a reasonable period for substantiation to be within 60 days after the expense is incurred.

The third requirement is the “return of excess reimbursements,” which stipulates that employees must return any amounts exceeding their substantiated expenses to the employer within a reasonable period. Failure to do so can result in the entire reimbursement being treated as taxable income to the employee. The IRS typically considers 120 days after the expense was paid or incurred as a reasonable period for returning excess funds. If any of these three criteria are not met, the plan is considered “non-accountable,” and all reimbursements become taxable wages to the employee, impacting payroll taxes for the employer.

Establishing Your Accountable Plan

Creating an accountable plan involves developing a formal, written policy that outlines the rules and procedures for expense reimbursement. This document should specify eligible expense types, such as travel costs, business meals, office supplies, or professional development. It must also detail substantiation requirements, including specific documentation employees must provide, and established timelines for submitting expense reports and returning any excess funds.

Once the written policy is established, communicate its terms and procedures clearly to all employees. This ensures employees understand their responsibilities regarding expense submission, documentation, and the return of excess reimbursements. Effective communication helps prevent misunderstandings and promotes compliance with the plan’s guidelines, which are designed to align with IRS regulations.

Setting up internal processes is also a practical action for implementing an accountable plan. This includes designating personnel responsible for approving expenses and outlining the administrative framework for processing reimbursements. The goal is to create a streamlined system that efficiently handles expense claims while maintaining strict adherence to the policy’s rules.

Managing Expense Reimbursements

Once an accountable plan is established, the ongoing management of expense reimbursements follows a defined operational flow. Employees initiate this process by incurring business-related expenses and submitting expense reports with all required documentation. Submissions should adhere to deadlines specified in the company’s written policy.

The employer then undertakes a thorough review and approval process for submitted expenses. This involves verifying that each expense complies with the plan’s policy, has a clear business connection, and is adequately substantiated by proper documentation. This review ensures only legitimate business expenses are reimbursed, maintaining the plan’s tax-advantaged status.

Following approval, the reimbursement process involves disbursing funds to the employee. If an employee received an advance that exceeds their substantiated expenses, or if an expense is partially or fully disallowed, the procedure for returning unsubstantiated or excess funds must be followed. The plan should clearly outline how and when employees must return these amounts to the employer.

Recordkeeping and Documentation

Maintaining accurate records is essential for an accountable plan, ensuring compliance with IRS regulations. For each expense, specific documentation is required, such as original receipts, invoices, and canceled checks. For travel, lodging, or car rental expenses over $75, itemized receipts are necessary, showing the payee, amount, date, and method of payment. Mileage logs are essential for vehicle expenses, detailing dates, destinations, business purposes, and miles driven for business.

Accurate and complete documentation serves as proof in the event of an IRS audit. These records demonstrate that expenses meet the business connection and adequate accounting requirements, protecting both the employer and employee from potential tax liabilities. Without proper substantiation, reimbursements may be reclassified as taxable income.

Regarding record retention, the IRS generally advises keeping business tax records for at least three years from the date the tax return was filed. Longer retention periods may be required in certain situations, such as six years if income is substantially underreported or indefinitely in cases of fraud or failure to file a return. For employment tax records, a retention period of at least four years is required.