There may be errors in spelling, grammar, and accuracy in this machine-generated transcript.
Jeremy Wells: Welcome to part three of this three part series on fringe benefits. In the last episode, we looked at two more types of fringe benefits that employers can provide to their employees to allow them to function better at work and enjoy, [00:00:30] uh, some occasional, uh, time off working condition, fringe benefits, and de minimis fringe benefits. If you haven't listened to that episode, uh, it's not critical to understand this one, but I definitely want to encourage you to go back and listen to that episode. And also part one, the episode before that where we talked about, uh, qualified employee discounts and then, uh, additional no cost services. So that's when the employer actually [00:01:00] provides services or offers discounts on its products or services to employees. So those are the first two in that episode. Those are the first two of eight fringe benefits listed in IRC section 132. The previous episode looked at the next two fringe benefits. So in this episode, we're going to look at the remaining fringe benefits, uh, discussed in IRC section 132 and what you're going [00:01:30] to find out, uh, once we get into this episode, is that there's not a whole lot to say, uh, about the four of them due to various reasons, mostly because they're either, uh, so specific in their application that we just don't have a lot of clients that they would apply to. Um, or at least in my firm, we don't. If your firm specializes in one of the groups covered by, uh, some of these benefits, then maybe you've got a little bit more business.
Jeremy Wells: But they're not very complex. Uh, fringe benefits. They're pretty specific to a particular group of people, or [00:02:00] the benefit has just been made, uh, ineffective. It's basically been, uh, disallowed by some legislative changes, some recent legislative changes. So I'll talk about, uh, all of that. I'm also going to talk about something that is not necessarily a fringe benefit, but is related to this concept of fringe benefits, and that is reimbursements to employees under what's called an accountable plan. You won't find that in section 132, but it is [00:02:30] very closely related, uh, concept. Anytime we're talking about moving money from the employer to an employee, we need to be very careful about how that happens. So either that's going to be in the form of a fringe benefit, and we're going to make sure that the employer is following the rules such that if the employer can deduct that, uh, payment or that value provided to the employee, then the employer gets the deduction. But we're also going to [00:03:00] try to make sure that we don't generate taxable income for the employee with a lot of these benefits, as I've described in the prior two episodes. And we'll get into a little bit more in this episode. It's very easy for an employer to skip part of the rules, or not fully understand the application of the rules, and actually create some taxable income for an employee.
Jeremy Wells: So it's important to understand these. It's important for tax advisors to be able to properly advise [00:03:30] their clients, their employer clients on how to offer these fringe benefits and make sure that employees aren't stuck with some taxable income. Also, make sure that the employer gets the deductible expense if that's possible as well. So in this episode, we're going to look at the remaining fringe benefits and some of the rules and descriptions of those benefits. [00:04:00] We're also going to look at accountable plans, make sure we understand those what makes a plan accountable as opposed to not an accountable plan? In other words, what makes those reimbursements to employees actually qualify for being excluded from employees reported income? And then how do we advise business owners on providing those fringe benefits and providing accountable plans to their employees? So [00:04:30] let's jump into looking at the last four fringe benefits that we have listed in IRC section 132. The first one is the Qualified Transportation fringe. Qualified transportation fringe includes four different kinds of benefit. This is transportation in a commuter highway vehicle in connection with travel between the employees residence and place of employment. [00:05:00] Otherwise, what we would call the commute. And so in general, we know that, uh, for uh, such as business owners, uh, for example, that those commutes are not a deductible expense. However, under this qualified transportation uh, benefit, it is possible for an employer to provide a fringe benefit within certain limits to an employee, uh, to cover the cost of some of that commute.
Jeremy Wells: Also included [00:05:30] here are transit passes. Again, very specific rules about how an employer could offer this benefit in terms of covering transit fare for employees. Obviously, this would make sense in larger cities where there's public transportation, but it was possible for employers to provide either the transit passes or to offset the cost of those transit passes for employees. Qualified parking is another qualified transportation fringe benefit [00:06:00] that's included here. And then the fourth one is qualified bicycle commuting reimbursement. Now, the thing to keep in mind with these qualified transportation fringe benefits is that the Tax Cuts and Jobs Act of 2017 disallowed any deduction for these fringe benefits unless the employer provides the transportation to ensure the employees [00:06:30] safety. That's the requirement here. So if there is some prevailing reason why the employer needs to ensure the safety of an employee, which we talked about that a bit with working condition fringe benefits in the prior episode. Again, if you didn't listen to that episode, Go listen to that one as soon as you're done here and that, uh, there is some overlap there between that, uh, working condition fringe with respect to [00:07:00] providing transportation, uh, to employees, especially when we're talking about, uh, vehicles that need additional security, such as bulletproof glass or a driver, a chauffeur that is trained in, uh, defensive driving, uh, techniques. So, you know, a lot of this is probably not going to apply to most of our small business clients.
Jeremy Wells: Right. Uh, we don't have a lot of small businesses that are in a situation where they're, uh, [00:07:30] normally as part of the, the business that they're conducting, uh, or the areas that they're operating in, going through having to deal with, uh, death threats or, or, uh, you know, threats of kidnaping that, this sort of thing. But if you happen to work with a client that is in this situation, then it's good to keep this in mind. So the qualified transportation fringe is only, uh, allowed in terms of the deduction [00:08:00] for the business if that qualified transportation is provided to ensure the employees safety. Now, Tax Cuts and Jobs Act made that disallowance effective from tax year 2018 to 2025. This year, uh, in 2025, the one big beautiful Bill act, the BBA or the Ob3, depending on who you're talking to. Uh, I refer to it as the OB. [00:08:30] Uh, made that disallowance permanent. So there is no deduction allowed. Uh, until we have another tax law change, there is no deduction allowed for the employer for the qualified transportation fringe benefit that does not affect the actual excludability of the benefit though. So because there's no deduction, there's really not a strong incentive [00:09:00] here for the business to provide that fringe benefit. However, if the employer wants to provide that fringe benefit, there are rules. Those rules are listed out in Treasury Regulation section 1.1329.
Jeremy Wells: As far as the limits on the transportation and commuter highway vehicle, uh, for the uh employee, uh, the transit passes, the qualified uh, [00:09:30] parking, the qualified bicycle commuting reimbursement. That was always a relatively small, uh, amount. Uh, I believe it was around the range of $25 a month or so. Uh, that, uh, has been completely eliminated, though there is no deduction for that. There is also no exclusion for that. And that is a result of Tax Cuts and Jobs Act. So beginning with tax year 2018, [00:10:00] the qualified bicycle commuting reimbursement is no longer, uh, a thing, uh, both for the employer as well as the employee. However, the transportation and commuter highway vehicle, the transit passes qualified parking. Those are nondeductible for the employer. They're still excludable for the employee within the limits described in that, uh, Treasury regulation, the, uh, disallowance, though, [00:10:30] uh, for the, uh, deduction that is in IRC section 274 A4, as well as subsection L there again, that is, Tax Cuts and Jobs Act disallowed that between 2018 2025. Obama made that disallowance permanent. The next fringe benefit listed in section 132 is the Qualified Moving Expense Reimbursement. [00:11:00] Under this fringe benefit, an employer can exclude from gross income reimbursements to employees of otherwise deductible moving expenses under IRC section 217. Irc section 217 defines those deductible moving expenses as reasonable amounts for moving household goods and personal effects from the former residence to the new residence, [00:11:30] and traveling between those two locations, including lodging but not meals for the taxpayer and members of the taxpayer's household.
Jeremy Wells: Now we know that the Tax Cuts and Jobs Act disallowed any deduction for moving expense reimbursements. We also know that it disallowed that deduction as a miscellaneous itemized deduction off of schedule A for individuals. However, [00:12:00] that disallowance of the deduction remains for members of the US armed forces on active duty who move pursuant to a military order and incident to a permanent change of station. The One Big Beautiful Bill act made the disallowance permanent and then added employee or new appointee of the Intelligence community, as defined in section three of the [00:12:30] National Security Act of 1947. Other than a member of the Armed Forces of the United States. So we have two groups now who still can get the exclusion and the exclusion of the reimbursement, and then the deduction is still allowed for members of the US armed forces, as well as members of the intelligence community, as defined in National Security Act of 1947. [00:13:00] That's all coming out of section 132 G in general. Uh, again, this is one of those fringe benefits that we just really wouldn't see that much, uh, anymore. And we haven't seen it that much since 2018 because of the lack of deductibility there for the business. This one, uh, hasn't been axed either under the Tcja or the Oba, though. And this is the qualified [00:13:30] Retirement Planning services. Fringe qualified retirement planning services means any Retirement planning advice or information provided to an employee and spouse by an employer.
Jeremy Wells: Maintaining a qualified employer plan. Now, qualified Employer plan means a plan, contract, pension or account described in IRC section 219 G five. So what does [00:14:00] this actually look like? This would be an employer paying for an investment advisor or financial advisor to give retirement planning advice or information to their employees. This is going to look like an employer having a company sponsored plan. And then that plan administrator or a representative of that plan administrator having the responsibility to advise [00:14:30] employees on their retirement planning and provide information about the plan, about the investments they could that they could make in that plan. That sort of thing. If you work for a larger company, this might be something that you've experienced when during your onboarding in that company, or perhaps when your initial period of working there, uh, your probationary period has elapsed. And then [00:15:00] now you can begin investing into your employer sponsored retirement plan. You need to pick, uh, one of the providers, uh, that is going to actually administer that plan, administer that account. And so you might meet with a financial advisor, uh, as part of that. So that's all going to be covered under this fringe benefit. There has not been any change to this fringe benefit either under, uh, Tax Cuts and Jobs Act or [00:15:30] OB or any other tax legislation. However, this fringe benefit does have a nondiscrimination policy attached to it, so highly compensated employees still qualify for tax free retirement planning services, but only if those services are also available on substantially the same terms to each member of the group of employees.
Jeremy Wells: Normally provided education [00:16:00] and information regarding the employer's qualified employer plan. So, in other words, those highly compensated employees can take advantage of this fringe benefit as long as they're not the only ones, as long as they are part of the group. That includes other employees that get substantially the same terms, have substantially the same access to that retirement planning, education and information related to the employer's [00:16:30] qualified retirement plan. This is all from section 132 M. And then there's the qualified military Base Realignment and Closure fringe. This is at the at the top of the episode. This is one of the, uh, most niche fringe benefits. Uh, probably that, uh, you could have in this list. This [00:17:00] one is particular for members of the military and then certain federal civil employees, civilian employees that are working, uh, either with the military or on these, uh, military bases or installations, they can exclude amounts received under a particular program. This is called the Defense Department's Homeowners Assistance Program. That program pays, [00:17:30] uh, Members of the military and those certain federal civilian employees for the adverse effects on housing values caused by realignment or closure of military bases or installations. This is really a, uh, I mean, it it still happens. It can still happen.
Jeremy Wells: This came to a head, especially during the 90s, the mid 90s, with the end of the Cold War at the end of the 1980s and early 1990s. [00:18:00] There was a lot of military base closures and realignment. A lot of military bases were consolidated or moved, and essentially they were downsized. Uh, a military base in near your hometown can really be a boon to the local economy. Uh, my hometown, uh, where I lived first, 18 years of life until I went to college, uh, was just about 15 minutes away from one of the largest military [00:18:30] bases in the US, and quite a bit of the local economy was driven by that military base. You get not only the actual service members that are living in that area, but you also get their families, and you also get the civilian workforce that is attached to that military base. So a lot of the people working on or around a military [00:19:00] base are not service members. A lot of them are civilians working in Department of Defense, maybe Department of State, maybe Department of Justice, and then as well as consultants, maybe they're working with defense contractors. A lot of the civilian workforce that is directly associated and tied to the military, but they're not in uniform. And so you get [00:19:30] a lot of this sort of population and, uh, really driving the economy in that local area. If a base realigns such that it's moved or consolidated with other bases, and so there's a reduction in that workforce, or if the base is just completely closed, then that can really have a significant, uh, and sometimes even just, uh, completely wipe [00:20:00] out, uh, but it can have a significant effect on a local economy.
Jeremy Wells: What that means for the individuals living there is they probably lose their jobs, um, or at least at least 1 or 1 member of that household. If you're talking about a traditional, uh, household with two income earners, then at least one, uh, income earner might lose, uh, a job, probably both will. And so they'll need to find other jobs, which is probably [00:20:30] going to lead to moving. The problem is, if the base is shut down and everyone in the area is losing their jobs, there's not going to be a lot of demand for people to move into that area. So selling a house could be pretty difficult. So what the Homeowners Assistance Program does is it basically reimburses those individuals for a portion of the decline in value of their homes. The exclusion itself [00:21:00] under the fringe benefit is limited to the amount of the reduction in the fair market value of the home. This is under section 132 N, and what ends up happening is legislatively this has been refined a little bit. So originally this was meant to, uh, provide a reimbursement for that decline in value. [00:21:30] There's a lot of leeway written into the law, though, that allows for refining the eligibility for the program, as well as giving the Secretary of defense and therefore, the Department of Defense, quite a bit of leeway in determining eligibility for the program.
Jeremy Wells: The US Army, uh, the just the the Army as a branch of the US military, is what's [00:22:00] called the Department of Defense's executive agent for administering the program. And then the US Army Corps of Engineers actually implements the program for the Army. So if you're interested in this or you have any clients that are affected or might be affected by this, they're going to be working through the US Army Corps of Engineers. There is a an official military benefits website, uh, run by the US Army that lists out all the particulars of this program. Right [00:22:30] now, the assistance under the program, it provides, uh, that reimbursement in one of, uh, three scenarios. The first one is a private sale. So the benefit is the difference between 95% of the home's prior fair market value and then the actual selling price. So in this case, you would probably need some sort of appraisal for what the value of the home was just before the announcement of [00:23:00] that, uh, base closure or realignment and then the what the home actually sold for. And so you would take 95% of that, uh, fair market value before the announcement of the closure and then the selling price and take the difference there. In some cases, the government will acquire, uh, those homes if it's really not possible to find buyers for them, and in that case, the benefit is the greater of 90% of the home's prior [00:23:30] fair market value or the mortgage payoff amount.
Jeremy Wells: And then finally, is foreclosure in the case where the home just can't be sold and government is not buying it, then the benefit is paid directly to the lien holder to settle the debt in the case of a foreclosure. So there are a few different ways that this can come about. Now, I mentioned that the Secretary of Defense and the Department of Defense has the ability to refine [00:24:00] eligibility for this program. Currently, the program is only available to wounded, injured, or ill soldiers and their surviving spouse applicants. So even though the fringe benefit is written in terms of these base closures or realignments, it might be possible for soldiers because we're not really dealing with that as much. What we're dealing with now is the veterans of wars in the [00:24:30] 2020 tens. In these cases, there might be some need for this, this fringe benefit. So there's a lot of rules and regulations here. It's going to be mostly up to the Department of Defense and the Department of the US Army. Check with that. If you uh ha. If you think you might be eligible, if you have clients that you think might be eligible, this is a little bit beyond actual, uh, tax law here, because so much of this is driven by, uh, actual [00:25:00] DoD and then, uh, law governing the military forces.
Jeremy Wells: However, uh, understand that there is a potential fringe benefit here. Uh, there is a potential exclusion, uh, if there is any sort of reimbursement provided to the service member or the service member's spouse in the case of one of these issues occurring. And I also wanted to discuss a couple of what I'm going to call miscellaneous fringe benefits. Now, these are fringe [00:25:30] benefits that are covered in either the regulations or they're covered in IRC section 274. They're not directly listed in section 132, but they are considered fringe benefits. The first one is achievement awards. These are for employees who either are awarded for their length of service with the company or for a safety achievement. [00:26:00] Now, there are some rules as far as what qualifies as for a length of service award or for a safety achievement for a for a safety achievement. The award doesn't qualify if it's awarded to a manager, administrator, clerical employee, or other professional employee. In other words, it needs to be awarded to someone that is actually in a line [00:26:30] of work within that company where safety could be an issue. In general, we're thinking of somebody working on a factory floor or on a construction site, something along those lines where there is a reasonable risk of personal injury on the job, not someone like me who most of the job is just sitting at a computer. Um, I guess it's possible for me to get injured doing this work, but it's not as likely as if someone is on a factory floor [00:27:00] or out on a construction site.
Jeremy Wells: And then also, there has to be not more than 10% of eligible employees previously receiving the Safety Achievement award during the year. So this can't be an award that's given to more than 10% of the workforce that are in a situation where they might, uh, be eligible to get this award. It really does need to be, [00:27:30] uh, a bonafide award to just a select group of employees or even an individual employee for safety. For the length of service award, the length of service has to be at least five years, so it can't be an annual award. In fact, it's got to be five years. Usually it's more along the lines of ten, 15, 20 years, although the, uh, the actual uh code says at least five years, not less than five years, uh, for that award. The award itself has [00:28:00] to be tangible. Personal property awards can't include cash, cash equivalents, vacations, meals, lodging, event tickets, securities or anything like, uh, anything I've just described. So the award needs to be, uh, usually, you know, the stereotypical, uh, achievement award for employees is a gold wristwatch. Uh, something along those lines. It [00:28:30] definitely can't be cash. Uh, you can't write a check to an employee for, uh, lasting with the company more than five years. Uh, that, uh, and call that a achievement award? An achievement award? That would just be a bonus, uh, paid to that employee.
Jeremy Wells: Uh, same thing goes for a safety achievement. All of those kinds of property, uh, don't qualify. So it can't be a cash. It can't be cash. It can't be a gift certificate. It can't be a gift card. [00:29:00] Those are all cash equivalents. It can't be a paid for vacation meal, lodging, anything like that, uh, event tickets or sporting tickets. Nothing like that. And no securities. No stock in the company, no bonds, nothing like that. The property has to be awarded to the employee as part of a meaningful presentation. In other words, it probably needs to be some sort of award ceremony, usually some sort of banquet, or even just an all hands meeting with the staff [00:29:30] where the award is given out. And then the property has to be awarded under conditions that don't create a significant likelihood of it being disguised compensation. Uh, the award is exempt and deductible for up to $1,600 for a qualified plan award, $400 for a non-qualified award, uh, per employee, per year. So what, then, is a qualified award plan? Well, that means an employee achievement award that's awarded as part of an established written plan [00:30:00] or program of the taxpayer, which doesn't discriminate in favor of highly compensated employees. So again, we have a nondiscrimination rule here, and it needs to be part of a written plan or program. The employees need to know and understand that there is this award program available to them.
Jeremy Wells: And so whether it's that length of service award or that safety achievement award, the employees need to be aware of the award and that award cannot exceed in [00:30:30] value, uh, up to $1,600 if there is that qualified, uh, plan. Another benefit here and this one can cause a lot of confusion, especially among my self-employed, uh, clients, is for athletic facilities. This means athletic facilities either owned or leased and operated by the employer. So the value of any on premises athletic [00:31:00] facility provided by an employer to its employees is excludable from the gross income of employees. If substantially all use of the facility is by employees, their spouses, and their dependent children. An on premises athletic facility includes any gym or other athletic facilities, so for example, a pool, tennis court, or a golf course that is owned or leased or rented and operated by the [00:31:30] employer. It does not need to be on the business premises. So when we say on premises, it can be separate from the actual businesses office or warehouse or factory, but it needs to be a location that is either owned or leased or rented by the employer, and that facilities use is only by employees, spouses and dependent children. [00:32:00] Membership in a health club. Country club, gym. Any sort of athletic or sports or physical fitness training program. None of that qualifies for an exclusion. Back to my self-employed clients.
Jeremy Wells: A lot of them, uh, are trying to stay in shape. They're trying to look good. They're creating content. They're meeting with clients in person. [00:32:30] They want to look good for their clientele. And I can't blame them. But they want to write off the cost of that gym membership. They want to make that a business expense. They want to not have to include that in their income if the business pays for it. And that's just not what the rule is. If they really wanted the to be able to exclude the value of that membership and have the business pay [00:33:00] for it, or if they want to make it a business write off, then their business would have to own or lease or rent and operate that facility for the exclusive use of the company's employees or spouses or dependent children. Most of the time that isn't the case, right? So just your generic gym membership, or working with a personal trainer or joining a country club, none of that is going to be, uh, qualifying for the exclusion [00:33:30] or really even qualifying to be a deductible expense for the business. This is all under IRC section 132. Four. This is probably, maybe not one of the most common, but I get this one pretty frequently. I get this question pretty frequently. How do I let my business write off my gym membership? Well, it's just not. It's just not a deductible expense that is inherently a personal expense.
Jeremy Wells: The only way to make it a deductible expense for the business and excludable [00:34:00] for the employees is for the business to actually either own, rent or lease the facility, and then provide it exclusively for the use of employee spouses and dependent children. And then the employer needs to actually operate. Uh, the now the employer can create, uh, a, an entity to actually operate it, but ultimately the employer has to have responsibility for owning, leasing or renting and then operating that facility. So those are [00:34:30] the miscellaneous, uh, fringe benefits. That wraps up coverage of the fringe benefits as listed in section 132. Right now, I want to switch gears into looking at accountable plans. First of all, we need to look at why we have, uh, this concept of the accountable plan, what this actually means for employers and employees. So first of all, in IRC section [00:35:00] 62, which is about adjustments to adjusted gross income. 62 A1 says that adjusted gross income means gross income minus certain trade and business deductions, including deductions allowed, which are attributable to a trade or business carried on by the taxpayer. If such trade or business does not consist of the performance of services by the taxpayer as an employee. So this is actually a restriction on [00:35:30] adjustments to gross income. In other words, if you are an employee, you are not allowed to deduct costs related to the performance of services as an employee from your gross income. You don't get any deductions for that.
Jeremy Wells: Now, it used to be that there was an itemized deduction. It was limited to 2% of the the excess of 2% [00:36:00] of AGI. But there was a deduction for employee related business expenses. That was an itemized deduction. It was not an adjustment to income. Back to talking about the changes made by Tax Cuts and Jobs Act that suspended that itemized deduction for tax years 2018 through 2025. And then OB made that change permanent. In this case we're talking about adjustments to gross income. There is no deduction [00:36:30] allowed for business expenses incurred while performing services as an employee. So how if as an employee, would you account for any expenses that you might incur by being an employee? By working as an employee? Now, generally this probably shouldn't happen, right? The employer should probably be covering these expenses. But we know that there are a lot of professions, there are a lot [00:37:00] of trades, especially where this happens. Uh, in I live in northeastern Florida. We have a lot of HVAC, uh, repair companies. So these are the companies that go around and they will check and maintain and repair air conditioners. Uh, in Northeast Florida, we can't live without air conditioning. Uh, pretty much for about 11 at least months of the year, people are running their air conditioners in order to stay cool. And so the HVAC companies are constantly [00:37:30] in business, and a lot of them have employees that are running around doing service calls in their trucks.
Jeremy Wells: They get to a site, they are ready to make the repair, but they're missing a part, or they're missing a piece, they're missing a certain tool that they need. And so they could go back to the shop and get that, or they could go to a hardware store that might be closer. The employee probably doesn't have a [00:38:00] business credit card issued by the employer. They probably don't have an expense account with that hardware store, so they use some personal cash. Buy the tool, come back, make the repair, then go back to the office. This is a very simple and somewhat frequent case with the HVAC companies that we work with, where the employee has a business related expense, but did not use employer funds or credit to make that purchase. Instead, the employee [00:38:30] spent their own personal funds, and in this case, because the employee was doing the work of the employer, this was not a personal expense. This was a business expense. The employee should expect to be reimbursed by that employer. So the question then is what is the employer do in that situation? And how does the employer communicate to its employees when and how those expenses will be reimbursed. So [00:39:00] again under IRC section 62, but now we're looking at 60 2A2. In general, an employee can make an adjustment to gross income for certain business expenses paid by the employee in connection with the performance of services as an employee under a qualifying reimbursement or other expense allowance arrangement with the employer.
Jeremy Wells: It doesn't matter [00:39:30] that the reimbursement can be provided by a third party. Sometimes employers will use third parties to make these reimbursements, to help employees substantiate the expenses, report the expenses, and that reimbursement might come through a third party, for example. So this is what in terms of the uh, law in terms of the tax code, gives us this concept of an accountable plan. [00:40:00] It's a qualifying reimbursement or other expense allowance arrangement. An employer can have more than one arrangement with respect to a particular employee, depending on the facts and circumstances. There's a lot of flexibility here. An employer can have multiple accountable plans, uh, or expense allowance arrangement. Employer can set up different arrangements or accountable plans for different employees or groups of employees. [00:40:30] It can also have different plans for different kinds of expenses. There's a lot of flexibility here. The rules for these accountable plans, uh, are pretty much all in one Treasury regulation section 1.622. This is where we get, uh, the rules for accountable plans. And this is really the implementation of this concept in the code of a qualifying reimbursement or other expense allowance arrangement. So [00:41:00] what are the criteria of a qualifying arrangement? First of all, there has to be a business connection. Second, there has to be substantiation of the expense. And then finally the employee has to return amounts in excess of expenses. If the cash to pay for those expenses was fronted to the employee, an arrangement that doesn't qualify.
Jeremy Wells: In other words, that doesn't meet all three of those criteria is a non-accountable plan. [00:41:30] Allowances, advancements and reimbursements paid under a Non-accountable plan have to be included in the employee's gross income. So if the employer has a reimbursement or some sort of allowance or advance system, but it doesn't meet all three of those criteria. Business connection substantiation and returning amounts in excess of the expenses, then that is a non-accountable plan, and any amount given to the [00:42:00] employee under that non-accountable plan are included in the employee's gross income. It's added to their compensation. It's added to their wage income. Again, this is why I think this concept of accountable plan fits in with talking about fringe benefits, because we're looking at how do we move money, how do we move value from the employer to the employee in a way that allows the business of deduction, if possible, while at the same time [00:42:30] being able to exclude that value from the employee's compensation from the employee's gross income? This accountable plan is what allows employers to do that. So by business connection we mean that an employer can provide advances, Allowances or reimbursements to employees only for allowable business expenses paid or incurred by the employee in connection [00:43:00] with the performance of services as an employee. One of the things that we have to keep in mind with these accountable plans is that the expense has to be ordinary and necessary for the employer in order for the accountable plan to cover the reimbursement of that expense, or for the employee to be able to use the advance or the allowance to spend the money on that expense, and the employee has to be spending that money [00:43:30] in connection with actually performing services as an employee.
Jeremy Wells: Now, payments to an employee, regardless of whether the employee actually incurs or is reasonably expected to incur bona fide employee business expenses, don't satisfy the business connection requirement and are treated as paid under a Non-accountable plan. So there is some flexibility here in how the employer gets the money to the employee. The [00:44:00] most common example of this that I see, especially working with S Corporation shareholder employees, is through reimbursements. So the S Corporation shareholder employee will have some expenses that are covered under that's corporations accountable plan. A lot of times this has to do with home office expenses. Uh, sometimes it is, [00:44:30] uh, business use of a personal vehicle. Those are two of the most common ones. And then there are a couple others, uh, sometimes a, uh, even though a, uh, an S corporation shareholder employee, uh, is actually an employee A lot of times they still think of themselves as self-employed, and in a lot of ways, the tax law still treats them as self-employed. One of the ways that that can happen, because they're even though they're running a corporation for tax purposes, it's a relatively informal [00:45:00] setup.
Jeremy Wells: A lot of times they're still paying for some business expenses out of personal funds, uh, or especially on personal credit cards. Sometimes this is because they get some rewards through those personal credit cards, and they don't want to give those rewards up. Sometimes it's because they pay for something online, and they use their personal account instead of the business account when they're purchasing that product or service and mistakenly use a personal [00:45:30] credit card or even a even personal funds when they meant to use business funds. In these cases, the corporation really should have made that purchase. Uh, the employee did. And so that is a bona fide employee business expense in those cases. For a lot of our clients, we'll help them deal with that. We won't see that in the business's bookkeeping because they paid personal funds out of it, however, will help them get a reimbursement [00:46:00] out of the business for that expense. Make sure that they have the business connection and then that they actually substantiate it, as I'll talk about here in a minute. Uh, but this is pretty common. Uh, with those types of clients, it can be especially common in larger businesses, though, where you have employees who work with a little bit of independence, uh, meaning that they're out making service calls or repair calls. Like I mentioned, the HVAC technicians operating in those parts of the country where there's [00:46:30] a lot of demand for help with air conditioners, for example, uh, they often have to make these kinds of service calls.
Jeremy Wells: They often have to pay these expenses while they're out making those service calls, and they may not have access to business funds or business credit cards. And so they're using personal funds to do this. It is possible for an employer to provide a per diem allowance. So just like the employer can use reimbursements, [00:47:00] they're also allowed to use advances or allowances. Per diem allowances can be used. An arrangement providing a per diem allowance that's computed on a basis similar to that used in computing the employees wages or other compensation, such as the number of hours worked or the miles traveled, can meet the business requirement. The business connection requirement only if one of the following two statements is true. First, the payer made a separate [00:47:30] payment or specifically identified the amount of the per diem allowance, or the payer computed the per diem allowance on a basis commonly used in the industry in which the employee is employed. This is probably going to be for workers that have to travel or drive quite a bit for their job, and so the per diem allowance would account for them needing to stay in a hotel room overnight or, uh, provide meals while they are actually [00:48:00] working on the job. So in these cases, it's going to be possible to make these per diem allowances as long as the way they're calculated is either a separate payment and it's specifically identified, or that it's computed on a basis commonly used in that employer's industry.
Jeremy Wells: In those cases, the per diem allowance would be allowed under an accountable plan. If neither of those is true, then [00:48:30] you're looking at a situation where that per diem allowance is just additional compensation to that employee. What absolutely cannot happen is that an employer looks back in the past and sees that it made payments to an employee, and those payments were characterized as wages, and then say, actually, that was a reimbursement. There is no recharacterizing of wages allowed under an accountable plan. So an arrangement that characterizes taxable wages as nontaxable [00:49:00] reimbursements or allowances doesn't satisfy the business connection requirement of the accountable plan rules. When we're talking about accountable plan, that plan has to be in place and it has to be forward looking. It can't be used to recharacterize payments recorded as wages already made. The IRS refers to this as wage recharacterization, because the amount being paid isn't an expense reimbursement, but rather a substitute for an amount that would otherwise be paid [00:49:30] as wages. This is coming from Revenue ruling 20 1225. In these cases, it's really important to just understand that those payments that were recorded as wages have already been made, and that's the way it is, and the accountable plan needs to be set up and taken into account moving forward, but not looking back. A lot of times we're setting these accountable plans up with our clients mid-year because either they didn't know about it when [00:50:00] they came to us and they're coming to us mid-year, or it's a relatively new business and they're already some expenses.
Jeremy Wells: There's already been some wages paid. We can't go back in the past and look at that and try to recharacterize some of those wages. That is not allowed as far as substantiation goes, for other reimbursements of other business expenses not governed by IRC section 274 D, which deals with some strict substantiation rules [00:50:30] for certain types of expenses, such as employee travel or meals. Employees have to provide substantiation sufficient to enable the payer to identify the specific nature of each expense, and to conclude that the expense is attributable to the payer's business activities. It's not sufficient if an employee merely aggregates expenses into broad categories, such as travel, or reports individual expenses through the use of vague non-descriptive terms such as miscellaneous [00:51:00] business expenses. That's all coming from Treasury Regulation Section 1.62 to 3. So it's best, even if the expense type isn't one of the strict substantiation. Required expenses of IRC section 274. It's really best to have employees substantiate specifically these expenses, basically turn in receipts and have, along with that, either a description or even a log of what those expenses [00:51:30] were specifically for, for reimbursements for travel, entertainment, use of a passenger automobile or other listed property, or other business expenses that are covered under IRC section 274 employees have to provide substantiation satisfying those requirements, so that includes the dates and durations of the event, that or wherever that expense was incurred, the location and the distance. [00:52:00]
Jeremy Wells: If we're talking about travel and mileage, the nature of the business reason or discussion for that expense, especially if we're talking about a meal or a meeting with a client and then a relationship, the identification of any of the other individuals involved. So did that employee meet with a vendor, with a client, with a customer, with a business partner? What was the actual purpose of the meeting? Who was the meeting with? Where did it happen? When did it happen? How long did it [00:52:30] happen for? If that meeting was two hours, that should be indicated, right? So typically this should all be recorded by receipts or contemporaneous logbooks. We should be familiar with the requirements here already, especially if we work with self-employed clients. It's a very similar set of requirements under the strict substantiation rules here of 270 4d, an arrangement meets the return of excess amounts requirement. If the arrangement requires the employee to return [00:53:00] to the payer within a reasonable period of time, any amount paid under the arrangement in excess of substantiated expenses. This is the third criterion here. For an accountable plan, IRS has the authority to issue rules for per diem or mileage allowances only, under which an arrangement doesn't require the employee to return the portion of the allowance related to days or miles of travel substantiated under rules prescribed in IRC 270 4d.
Jeremy Wells: Yeah, I'm reading a little bit here because basically what we're [00:53:30] saying is that employees have to timely return those advances or allowances. So if you give an employee $100 to go drive across the county to go meet a client and then come back, you need to get the return of the excess so you know it did not cost them $100 because they're handing you receipts worth $40. Then you need to also get the additional $60. Otherwise, [00:54:00] that excess is going to be includable in that employees wages as compensation. The amount on the receipts needs, plus the excess that's returned, needs to equal the amount that you advanced or gave as an allowance to that employee. Failure to maintain an arrangement causes inclusion. This goes back to what I said earlier, that a qualifying expense allowance arrangement must include a mechanism or process to determine when [00:54:30] an allowance exceeds the amount that may be deemed substantiated. In other words, like I just said, look at the receipts, count up how much that was, subtract that from the amount that was advanced, uh, to the employee. And the difference is what needs to be returned. If an arrangement routinely pays allowances in excess of the amount substantiated without requiring actual substantiation of all the expenses or repayment of the excess amount, then all the payments, all [00:55:00] the payments, not just the excess, but all the payments made under the arrangement, have to be treated as made under a non-accountable plan.
Jeremy Wells: And then that means included in the employees income. That's from revenue ruling 2006 56. So again, this is one of those cases where you really want to make sure your client, if you're working with employers, is on top of the rules here, because this could create a situation where that employee certainly has a lot of suddenly has a lot of reported income to them. There [00:55:30] is a safe harbor here that if the employer provides employees with a periodic statement, at least quarterly, stating the amount paid under the arrangement that exceeds the expenses the employee has substantiated, and the employee, uh, is asked to substantiate any additional business expenses or return the amounts remaining unsubstantiated within 120 days of the statement. Then the expense, substantiated [00:56:00] or amount returned within that period is treated as being substantiated or returned within a reasonable period of time. So, in other words, the employer needs to provide a quarterly statement, at least quarterly to the employee saying this is how much we've advanced to you. This is how much you've substantiated, this is how much you need to return. And then give the employee no more than 120 days once they receive that statement. To actually do that, to actually return that excess, then it still qualifies as a as an accountable plan. [00:56:30] That's the safe harbor. It can be more frequent than that. It could be monthly. There could be a 30 day turnaround.
Jeremy Wells: In other words, there's some flexibility here, but the employer needs to stay on top of the plan. I want to briefly mention that all of this discussion of accountable plans is about employers and employees. None of this, as far as I read in the text of IRC section 62 [00:57:00] or Treasury Regulation 1.622. There's nothing in here indicating anything about two specific groups that I want to call out. The first one is independent contractors when it comes to payments made to an independent contractor, because that individual is not an employee. Those amounts need to be included in the gross income that's reported as payments to that independent contractor. In other words, those reimbursements need to get added to what's reported on the 1099 neck, even [00:57:30] if they're not payments for services, because those payments are made to that independent contractor. Those amounts should not be considered excluded reimbursements. They should be considered part of the payment to that contractor. The contractor then could then could turn around and deduct as a normal business expense those amounts paid. And so having to worry about this being a reimbursement and an accountable plan really doesn't make sense. Include the amount [00:58:00] reimbursed as a payment to that contractor and then let the contractor deduct the expense. The second group here is partners in a partnership. It's not clear one way or the other whether partners can be covered by an accountable plan by a partnership. Now if the partnership has employees, then the partnership can absolutely have an accountable plan for those employees.
Jeremy Wells: But it's not clear whether partners can participate in that accountable plan or not. I'm of the opinion [00:58:30] that it's not appropriate to have an accountable plan for a partner, because we need to discuss reimbursements for partners in the operating agreement or in the partnership agreement. The and this gets back to the concept of unreimbursed partnership expenses. So if the operating agreement or partnership agreement specifically discusses reimbursements for partners, then either the partnership reimburses the partner under that plan or the [00:59:00] partner deducts those expenses if a reimbursement isn't allowed or isn't given as unreimbursed partnership expenses and takes that deduction right on schedule E page two. So I don't really see a case for using accountable plans for partners in partnerships, although there's nothing in the accountable plan regulation that prohibits that use. I just don't think partners in a partnership count as employees for purposes of an accountable plan. So [00:59:30] whether we're talking about fringe benefits or we're talking about accountable plans, it's really important for employers to understand the rules whenever they are providing any sort of benefit or compensation to employees that they want to be deductible and or excludable for the employee. They need to make sure that they're following the rules for that particular fringe benefit or for that accountable plan. Otherwise, it might result in contributing to additional reportable income for [01:00:00] that employee, and nobody really wants that. So that wraps up this three part series on fringe benefits and accountable plans. Thanks for listening as always.