Professional Services Accounting ARTICLE -
Make sure your employee reimbursement plan satisfies the IRS

Target Audience: Legal Professionals, Professional Service Firms, Law Firm Partners, Law Firm Accountants

Law firms that compensate their employees for expenses incurred in the course of employment generally deduct those reimbursements as business expenses, rather than reporting them as wages on the employees’ Forms W-2. But the IRS permits such deductions only for reimbursement or allowance arrangements that qualify as “accountable” plans.

Criteria for an accountable plan

For a plan to be accountable, your firm’s employees must satisfy three requirements. They must have:

• Paid for or incurred deductible expenses while performing services as the firm’s employees,
• Adequately accounted to the firm for these expenses within a reasonable period of time, and
• Returned any excess reimbursement or allowance within a reasonable period of time.

To adequately account for their expenses under the second requirement, employees must provide the firm with substantiation of their travel, mileage and other employee business expenses. For example, they must supply receipts and a statement of expenses, account book, day planner or similar record where the employee entered each expense at or near the time it was incurred.

For the third requirement, an excess reimbursement or allowance is any amount a firm pays an employee that exceeds the business-related expenses for which the employee has adequately accounted. If your plan advances money to employees, the third requirement will be met only if the advance is reasonably calculated not to exceed the amount of anticipated expenses and the firm makes the advance within a reasonable period of time.

Defining “reasonable period of time”

The IRS has recognized that a reasonable period of time depends on the facts and circumstances. Generally, however, it will deem actions that occur within the following time frames to have taken place within a reasonable period of time:

• The firm gives an advance within 30 days of the time the employee incurs the expense,
• The employees adequately account for their expenses within 60 days after expenses were paid or incurred, and
• The employees return any excess reimbursement within 120 days after expenses were paid or incurred.

Keep in mind that your firm must give a periodic statement (at least quarterly) to its employees asking them to either return or adequately account for outstanding advances, and they must comply within 120 days of the date of the statement.

Many firms avoid the headaches associated with advances by instead reimbursing employees weekly or monthly for out-of-pocket expenses expended on the firm’s behalf. To receive reimbursement, employees must submit expense reports with attached receipts and adequate documentation.

Reporting reimbursements

Firms with accountable plans based on actual expense reimbursement or a per diem or mileage allowance need not report any amount on employees’ W-2s if an adequate accounting is made and any excess is returned.

If an adequate accounting is made but the excess isn’t returned, you must report the excess amount as wages.

Protect yourself and your people

Expense reimbursement, whether in the form of actual expenses or allowances, can prove costly if your firm doesn’t maintain an accountable plan. Any reimbursement will be subject to employment tax for the firm and both employment and income tax for the employee who receives it.

Find out how our expertise in professional services accounting can add value to your business. Email us or call us at 1 (888) 875-9770.

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