You may think the busiest days for CPA firms come somewhere around the March and April filing deadlines, but it isn’t true. No, our busiest days are the last few days of the year. It’s in these days that we make sure we’re available to answer any last minute questions our clients may have (that’s fun) and we make sure we pay as many bills as we can (that’s not so fun). We have to get those last minute deductions just like everyone else. Our creditors love it, but our bookkeepers absolutely despise it. Every time an employee brings in another expense report, or a partner thinks of a last minute expense that must be paid, the poor bookkeeper has to run another check.

Now we could say that this last minute flurry of activity is simply a case of practicing what we preach, but there’s a little more to it than that. Our real concern is that we did the same thing last year. Yes sir, last January looked really good because we paid most of the recurring expenses on December 31 of the prior year. If we don’t do the same thing at the end of the current year, we’ll only have eleven months of expenses and we will be clobbered by taxes.

Many of us would like to reduce this year-end madness, but those with employees who travel may have a tough time getting those last few expense reports to pay them by year end. You see, many of us have what’s known as an “accountable plan” to keep us from having to treat the reimbursements as taxable income to our employees. Of course, our real motivation for this type plan is to save the employee tax dollars, but we sort of like the fact that we save on Social Security and Medicare taxes by keeping the reimbursements out of our employees’ wages.

Here’s how it works. Say an employee takes a trip to a gold mine in Nevada to start the audit work before year-end. The employee, of course, has certain expenses like lodging, food, laundry, tips, car rental and the like. It’s not really fair for us to make the employee go to Nevada and pay for his or her own expenses, so we reimburse reasonable expenses; gambling losses are not reimbursable.

When the employee returns on December 30 for the big New Year’s Eve party, he or she stops by the office and turns in an expense report. Here’s what has to be on or with that report for us to deduct the expense and while keeping the payment out of the employee‘s wages:

• First, the employee must document how the expenses incurred relate to our business. There must be a business purpose for the trip. In our example, we sent the employee to Nevada to work at a client’s location. Since our employee is in Nevada to serve a client, lodging, rental car expense, meals, incidental expenses like laundry, tips, telephone calls back home and similar items are deductible expenses. Again, the $50 our employee lost on the slots is not reimbursable.



• Second, the employee must substantiate the amount, time (as in calendar date), place, use and business purpose of the expense. That’s why we use a standard expense report to capture the information. The evidence given must be submitted to us within a “reasonable” period.



• When we advance money to the employee, any advance in excess of the substantiated expenses has to be returned to us fairly soon after he or she returns home. If we don’t make that a condition of the advance, then we have a “non-accountable.” Payments made under a non-accountable plan are treated as wages to the employee subject to all the customary payroll taxes. Most employees don’t like this type arrangement and for good reason, but that topic is covered a little later.

How do you like that? The employee gets all of his or her money and we get our deduction. The same thing would hold true in your business if you chose an accountable plan, but make sure you cut a reimbursement check independent of the payroll check. If you must pay both wages and expense reimbursements on the same check, at least show the reimbursement as a separate line item on the payroll check. Anything less and your friendly IRS agent will be happy to point out that you don’t have an accountable plan. That would be fine, except then you would have to withhold Social Security and Medicare taxes from the payment plus you would have to pay the employer portion of those taxes. Federal and state unemployment taxes are generally applicable as well.

We told you employees have a good reason to dislike non-accountable plans - they cost the employee a fair amount of tax. Assuming the employee hasn’t maxed out on Social Security wages, he or she will have Social Security and Medicare taxes withheld. The employee’s check will also be reduced for income tax withholding. Finally, to add insult to injury, the employee will show the income in wages and the expenses as employee business expenses on Schedule A, if he or she itemizes. Employee business expenses are deductible only to the extent that they exceed 2% of their adjusted gross income. Your employee will definitely not like this arrangement.

Assume your employee’s adjusted gross income is $75,000 and included in that income is $5,000 in expense reimbursements. Assume further the employee can itemize and is in the 25% bracket. Under an accountable plan, that $5,000 would be excluded from income and, thus, the employee would get $5,000 to pay the $5,000 in expenses incurred. Under a non-accountable plan, the employee would get $4,242.50 ($5,000-Social Security and Medicare tax of $382.50-25% of 2% of adjusted gross income floor on employee business Expenses or $375) to pay the $5,000 in expenses. The employee loses $757.50 in the deal.

The bad news doesn’t stop there. Since you have to pay the same Social Security and Medicare taxes the employee pays, you pay $382.50 to Uncle Sam also. The result is the $5,000 in expenses effectively costs $6,140.00 between you and your employee.

So you don’t like the paperwork of the accountable plan, but the added cost of the non-accountable plan seems rather steep. What do you do?

The federal government will allow you to use what it considers reasonable per diem amounts to cut down on paperwork. Per diem rates are the rates the federal government believes are reasonable for meals, lodging, laundry and similar expenses. They are made up of two components: 1) lodging costs and 2) Meals and Incidental Expenses (“M&IE“). Here’s how it works.

You tell your employee to go to Anchorage Alaska for the month to count ice cubes. The employee goes and, upon his or her return home, you are presented with reimbursement request for $8,316 and a statement showing that the employee was in Anchorage for the month of August for ice cube inventory count observation. The number was determined using the maximum Federal Per Diem for a trip to Anchorage in the month of August 2003 ($236 x 31) and the actual cost of transportation and phone calls back to the office of $1,000.

Assuming the employee claims no more than the Federal per diem for lodging, meals and incidentals, and documents other expenses, the IRS will assume the costs are substantiated. Along with a statement of the time, place and business purpose of the trip will suffice to validate the expenses.

The IRS will also allow you to use what is known as the high-low method of expense reimbursement for travel within the Continental United States (Alaska and Hawaii have special tables). In essence, the IRS will accept a daily per diem of $204 ($162 for lodging and $42 for meals and incidental expenses) in a high cost locality and $125 ($91 for lodging and $34 for meals and incidental expenses) in a low cost locality. High cost localities are generally large cities like Boston and Los Angeles or resort areas like Aspen, Colorado and similar resorts. The IRS provides a table to help you determine the proper rate to apply.

A couple of caveats apply. If you start using the high-low method at the beginning of the year, you must use it for the whole year. If, however, you want to go to reimbursement of actual costs, or payment of M&IE per diem for a specific locality, you can make that switch if you do it before the end of the calendar year. Finally, if you want to use the high-low method, you must also use the per diem substantiation method for travel outside of the United States.

By the way, if you are a sole proprietor you can only use the M&IE per diem rates. You must show actual expenses for lodging.

There are a few other nuances to this business of substantiating business expenses and making the best use of the available rules that we won’t go into here. However, if you or your employees travel, it is imperative that you properly document travel expenditures to minimize the tax impact to you and your employees. If you need help designing the best reimbursement plan for your business, give us a call. We’re always ready to help you make life easier on yourself and your employees.

Have a great August and don’t forget to keep our troops around the world in you hearts and prayers until they return safely home.