Prior to the passage of the Tax Cuts and Jobs Act in 2017, W-2 employees had the ability to deduct unreimbursed job-related expenses paid with personal funds as miscellaneous itemized deductions on their personal income tax returns. But the TCJA suspended most miscellaneous itemized deductions (including unreimbursed employee business expenses) through 2026, eliminating the opportunity for employees (including S corporation owners who also serve as employees of those companies) to deduct business expenses on their individual returns.
But the good news for S corporation owner-employees is that, by implementing an “Accountable Plan” a (a reimbursement program which meets certain IRS regulations), S Corporation owner-employees can continue to deduct business expenses that they pay for personally by “passing” them along to the business. Essentially, an Accountable Plan is an IRS-approved reimbursement program that allows a business to reimburse employees for business expenses they incur as part of their work. The business is then able to deduct those reimbursed amounts as if the business had incurred the initial expense, itself.
When using an Accountable Plan, reimbursements for business expenses are not considered compensation to employees thus, don’t increase payroll taxes due on wages or an employee’s income tax liability. However, it’s important to note that the deductibility of an expense incurred by an employee isn’t changed when submitted for reimbursement to an employer. Thus, any limitations or restrictions inherently associated with a deductible expense remain in place (e.g., the 50% deductibility of meal expenses).
There are three simple guidelines an Accountable Plan must follow to be considered valid: 1) all expenses to be reimbursed through the plan must have a business connection, 2) expenses must be “timely substantiated,” and 3) any excess advances provided to the employee must be “timely repaid.” While the actual definition of “timely” (with respect to substantiation and repayments of advances) is somewhat ambiguous, the IRS has provided several “safe harbor” options.
Since Accountable Plans are so simple to establish, and since they offer such flexible rules around to whom they can apply, and to which expenses they will cover, there is generally no reason for most S Corporations not to implement them. For example, the Accountable Plan can be designed so that only certain expenses can be reimbursed, and/or so that only specific employees can participate.
Despite their simplicity, though, business owners should understand that if the IRS does not deem their plan in compliance with the Accountable Plan rules, their plan will be treated instead as a “Non-Accountable Plan”. In such instances, any reimbursements will be added the employee’s wages. Even though employee wages reduce gross business revenue, that reduction is offset by the increase in wages. And to top it off, the impact of higher FICA taxes as a result of those wages means that the total tax liability will be higher than if the expense hadn’t been reimbursed in the first place!
Ultimately, the key point is that an Accountable Plan is a simple way for S Corporation owner/employees to shift deductibility of business expenses from the employee to the employer and offers the ability to mitigate tax liability by allowing business owners to choose which expenses are reimbursable and which employees will be eligible to submit reimbursements. Thus, in light of TCJA and the suspension of miscellaneous itemized deductions, for S Corporation owner-employees, in particular, Accountable Plans are an especially effective tax planning tool.