Before January 1, 2018, Employees, who itemized their deductions on Schedule A of Form 1040, could deduct their appropriate unreimbursed employee expenses that were greater than 2% of their Adjusted Gross Income (line 37 on Form 1040. This is no longer possible.
The Tax Cuts and Jobs Act of 2017 (TCJA) suspends all miscellaneous itemized deductions that are subject to the 2 percent of Adjusted Gross Income Floor. This change affects unreimbursed employee expenses such as uniforms, union dues and the deduction for business-related meals, entertainment and travel expenses in taxable years beginning after Dec. 31, 2017, and before Jan. 1, 2026.
While this new rule may change, currently this is the law and it may have a financial detrimental affect upon an employee’s financial “bottom line”; i.e. their spendable income, after tax. Lost deductions may mean a higher taxable income and tax expense. 2018 is about 5/12 over and now is the time to make adjustments – before 2018 is over and it essentially may be too late.
Employers can use an Accountable Plan to reimburse their employees, for allowable business expenses, without having this amount added as compensation to the employees W2.
With an “Accountable Plan”, the employer’s advance, reimbursement or allowance arrangement must include all of the following rules:
- The expense must have a business connection – the employee must have paid or incurred deductible expenses while performing services as an employee of the employer
- There must be an adequate accounting of these expenses to the employer within a reasonable time – expense report with receipts; some may qualify to use the Per Diem method
- Generally, the expenses must satisfy the substantiation requirement – the employee must report the amount, time, place, and business purpose. An easy way to remember this is to use the 5 “W’s:
- Who? – Business Relationship
- What? – Type of Expense
- Where? – Place
- When? – Date
- Why? -Business Purpose
The employee must return any excess reimbursement or allowance within a reasonable time
- Under an IRS “safe harbor” the following payments are considered to be made within a reasonable time
- Advance Payments- given to you within 30 days prior
- Substantiation of Expense – provided within 60 days
- Return of Excess- done within 120 days of paid or incurred
Substantiation must be done and the Excess Amount be returned within a reasonable period of time. If this time requirement is not met, the unsubstantiated or excess amounts are treated as reimbursements under a “Non-Accountable Plan”.
A “Non-Accountable Plan” is one that either does not require you to adequately account for your expenses or allows you to keep any excess reimbursements or allowances, over the expenses for which you did adequately account.
- Employers report the reimbursements or allowances as part of your salary income in Box 1 on your W2, which is subject to FICA tax (Social Security and Medicare) withholding
In addition, even if your employer has an Accountable Plan, the following payments will be treated as being paid under an Non-Accountable Plan:
- Excess Reimbursements
- Reimbursements of nondeductible expenses
New Law and New Procedure?
The TCJA is in its infancy. It is less than 5 months old and many are still learning about it. This blog was specifically written to help provide information for both employees and employers. Financial Education, including tax rules, can make a difference and possibility prevent others from getting hurt financially.
Perhaps, for some, changing the compensation agreement might produce a Win/Win:
- Employees might consider a “salary reduction” if the employer reimburses them for their business expenses that are no longer deductible as a miscellaneous itemized deduction
- The employee benefits by having some or all of his expenses paid for and also reduces their taxable income and payroll tax
- The employer benefits by reduced payroll tax and they can take a business deduction for the qualifying “ordinary and necessary” expense
- Some Employees might decide they will do better by being an Independent Contractor where they could use Schedule C and deduct expenses as a Sole Proprietor.
When evaluating your options, remember to evaluate both federal and state rules before you act; i.e. Look before You Leap.
If you are an employer, you can take the lead and help employees:
- Be proactive and consider telling employees they cannot deduct employee related business expenses on their tax return, which may affect their 2018 annual tax bill. Tax planning can help and payroll withholding can be adjusted if necessary. Sooner is better than later.
- Education helps to prevent unexpected financial surprises
- Remember, S-Corporation Owners can be both an Investor and an Employee Shareholder. S Corporations may want to consider an Accountable Plan for their Shareholder Employees to obtain reimbursement for their business related expenses such as mileage, travel, and meals.
In closing, it is always good to remember Ben Franklin’s famous quote “Beware of little expenses. A small leak can sink a great ship.” While the unreimbursed expenses may never sink a ship, evaluating options to identify cost savings is a smart thing to do. I understand most people do not like “tax”, but most of us like to save money. Right?
Thanks for reading.
To your success,
Deborah Ann Fox, CPA helps Small Business Owners & Individuals build and protect their financial wealth though education, strategy, and proactive tax planning. Deb thinks this is the fun part of tax because it makes a financial difference for her clients, their business, and their families.
She offers free 30 minute no obligation consultations. We can discuss/resolve via a mix of e-mail, phone, virtual, and in-person communications.
E-Mail me @ firstname.lastname@example.org
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The blog is provided as general information only and should not be considered a substitute for the advice and services of an Attorney, Certified Public Accountant or Enrolled Agent.