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September 2007 IRS scrutiny on expense reimbursement plans The consequences of an out-of-compliance expense reimbursement arrangement can be pretty harsh When a company properly reimburses an employee for travel or other out-of-pocket expenses, the company receives a tax deduction for its expenditures, and the employee does not have to include the reimbursement in his taxable income. No wage reporting or payroll taxes come into play. To meet IRS rules on expense reimbursements, employers generally have two choices: they can reimburse actual expenditures incurred by each employee, or they can use IRS standard allowances. To simplify recordkeeping, many employers have moved to these IRS standard allowances, such as the current 48.5¢ per mile business mileage rate. For out-of-town travel costs, there are several choices for standard per diem allowances to reimburse meals and lodging. For example, a full day of out-of-town, overnight travel can result in a $45-per-day meal allowance, or even a $58-per-day amount in specified high-cost locations. Similar standard amounts exist for lodging costs. As an alternative, employers may use the approved per diem travel and lodging amounts that are specific to each travel locale. In late 2006, the IRS issued a tough ruling, holding that employers who do not follow either actual reimbursement or IRS-approved standard allowances, and are found to be reimbursing employees at a rate greater than those allowances, will have their reimbursements recharacterized as wages. This interpretation was particularly aimed at the trucking and construction industries, where employees apparently were receiving meal allowances that are based on miles traveled and that are in excess of the various IRS-approved per diem amounts. When this occurs, the onus falls entirely on the employer to demonstrate compliance. The IRS plan was to recharacterize the entire reimbursement – not just the excess – as wages, and charge the employer with all delinquent payroll taxes and penalties. Fortunately, in recent administrative guidance, the IRS has taken a more reasoned approach. Where employers have used expense allowance arrangements that do not properly comply, the IRS has indicated that its examiners will not impose wage treatment in prior years unless there has been a pattern of abuse or evidence of intentional noncompliance. Further, for periods beginning in 2007 and after, the IRS will tax as wages only the portion of the employer reimbursements that exceeds the federal per diem limit, unless the employer plan evidences a pattern of abuse or the employer has no system for tracking whether excess payments have occurred to employees. The consequences of an out-of-compliance expense reimbursement arrangement can be very serious, so please let us know if you have any questions regarding your specific expense reimbursement policies. Based in Mesa, Arizona, and serving closely held businesses in the East Valley, the Phoenix area and throughout Arizona, Schmidt Westergard & Company, PLLC, is an independent full-service tax, audit, accounting and business advisory firm focusing on the middle market. |
