COVID-19 Increases Focus on Employee Reimbursement
October 06, 2020
By Solomon Dado
As a result of COVID-19, many more employees are now forced to work from home for an extended period of time. While it is uncertain whether this work model will continue, many employees have inquired about a work-at-home tax break. Are employees of a company allowed to take a home office deduction? While the home office deduction has been around for many years, this benefit became limited under the 2017 Tax Cuts and Jobs Act (“TCJA”). Employees earning W-2 wages working for an employer are no longer allowed to take the home office deduction. Additionally, the deduction for unreimbursed employee business expenses is also suspended post-TCJA. There is an important distinction between self-employed individuals and employees. Self-employed individuals are still able to deduct their home office expenses along with any ordinary and necessary business expenses in their trade or business.
So while employees may be out of luck in claiming a tax deduction when making purchases to upgrade their home offices, there is a way that employers can assist their employees while also taking advantage of their own tax deduction. An accountable plan is a long-standing method in which employers can assist their employees by providing reimbursements for expenses that are excluded from employees’ W-2 wages and are exempt from income tax withholdings and employment taxes. These reimbursements under an accountable plan are generally deductible by businesses as an ordinary and necessary business expense. Under this plan, an employee may be fully or partially reimbursed for items purchased for business use such as computers, monitors, printers or other equipment.
Reg. §1.62-2(c), states that an accountable plan requires employers to comply with three standards:
- Expenses being reimbursed have a business connection;
- Employees must substantiate the expenses covered by the arrangement; and
- The employee must return to the employer any amount in excess of the substantiated expenses that was not spent within a reasonable time period.
Under Reg. §1.62-2(d), the expenses being reimbursed must have a business purpose. The accountable plan can provide for advances, allowances or reimbursements for business expenses. The expenses must satisfy the requirements for the deduction as a business expense and be paid or incurred by an employee in connection with the performance of services as an employee. If the employer later converts any of these items to personal use, they would have to pay tax on their value.
Substantiation of Expenses
Under Reg. §1.62-2(e), employees must provide sufficient substantiation of the reimbursed expense to the employer. There are different substantiation requirements for different types of business expenses. If a deduction for an expense is governed under a different code section, those requirements will also apply for purposes of the accountable plan. However, a good starting point for the substantiation requirement is employee receipts. All expenses should be substantiated within a reasonable time period from the date when the expenses was incurred.
Excess Funds Returned to Employer
Under Reg. §1.62-2(f), an accountable plan must require employees to return to their employer within a reasonable period of time any amount paid under the arrangement in excess of the expenses substantiated.
Reasonable Period of Time
A reasonable period of time is not specifically defined provided in the code; Reg. §1.62-2(g)(1) describes that it will depend on facts and circumstances. Furthermore, Reg. §1.62-2(g)(2)(i) provides two safe harbor methods for determining a reasonable period of time:
Fixed Date Method
- An advance made within 30 days of when an expense is paid or incurred;
- An expense substantiated to the employer within 60 days after it is paid or incurred; or
- An amount returned to the employer within 120 days after an expense is paid or incurred will be treated as having occurred within a reasonable period of time.
Periodic Statement Method
The employer provides periodic statements to their employees notifying them of any excess amounts paid under the plan over expenses substantiated by the employee. These statements must be provided at least quarterly and request that any unsubstantiated amounts be substantiated or any excess funds be returned within 120 days of receiving the statement.
If an employer or employee fails to comply with any of the requirements of the accountable plan, the plan will be treated as a “non-accountable plan” and become includible in the employee’s wages and subject to income tax withholding and employment taxes.
Establishing the Plan
Setting up an accountable plan for a business is relatively straightforward, but the guidance on how to establish a plan is limited. The best way to establish a plan is to formalize it in writing. The more detailed the policies and procedures, the more likely the plan will be in compliance with the accountable plan rules. The plan should, at a minimum, establish the types of expenses that can be reimbursed, clarify that only expenses with a business purpose can be reimbursed, the timeframe for advances, substantiation and reimbursements.
Qualified Disaster Relief
Another way an employer could make tax-free reimbursements for the home office expenses of their employees is to characterize those payments as qualified disaster relief payments. There is a provision under IRC Sec. 139 that allows employers to make tax-free payments to their employees to either reimburse or pay them for such reasonable and necessary expenses they incur during a national emergency. The COVID-19 pandemic has been declared such an emergency. Qualified disaster payments would include reimbursing employees for expenses incurred in setting up a home office such as equipment purchases, internet service, cell phone service and other related expenses. One difference is that these type of payments do not need to be made under an accountable plan and, thus, avoid the extensive recordkeeping requirements required under such a plan. Unlike an accountable plan, these payments will only qualify as tax free during a national emergency, so their utilization may be limited in both scope and duration.
The accountable plan, an often overlooked tool businesses can use to assist their employees in light of the TCJA elimination of the unreimbursed business expense deduction, is more useful than ever and can be a huge incentive for both businesses and employees alike. Under an accountable plan, a business can benefit from a tax deduction while incentivizing employees to improve their home offices—thereby increasing productivity and efficiency. Regardless of whether a business chooses to set up an accountable plan or not, it is definitely a powerful strategy that is worth considering and discussing with your trusted business advisor.