QUESTION: Subject to only a few, narrowly defined exceptions, our company generally does not reimburse employees for any business expenses they incur. Can our employees take business expense deductions on their personal income tax returns for those unreimbursed expenses?
ANSWER: Many employees spend a portion of their compensation on work-related expenses, but recent changes to the Code have adversely affected the deductibility of those expenses.
Prior to 2018, the after-tax cost of work-related expenses could sometimes be diminished by claiming those expenses as miscellaneous itemized deductions under Code § 67. Expenses that could qualify as miscellaneous itemized deductions included ordinary and necessary expenses incurred in the trade or business of employment (i.e., expenses deductible under Code § 162), but only to the extent that the deductions in the aggregate exceeded 2% of the individual’s adjusted gross income, and any expense-specific conditions were satisfied. The deductions were not available for expenses that could have been reimbursed by the individual’s employer but were not submitted. Miscellaneous itemized deductions could include expenses for business travel, transportation, meals, tools and supplies, professional dues, uniforms, and home office equipment and supplies. (For more information, see IRS Publication 529.) The deductions did not make employees whole, but they did reduce the after-tax cost of their expenses, relieving some of the pressure on employers to provide reimbursements.
For tax years after 2017 and before 2026, however, the situation has substantially changed due to the suspension of all miscellaneous itemized deductions by the Tax Cuts and Jobs Act (TCJA). Without a deduction, the after-tax cost of unreimbursed employee business expenses is increased. So, to reduce employee dissatisfaction over loss of the deduction and avoid discouraging employees from making expenditures that benefit the employer, employers may wish to reconsider their reimbursement policies and strategically expand them to cover all or a portion of certain expenses previously borne by employees.
Work-related reimbursements under an “accountable plan” generally are not taxed—so the employer is relieved of its withholding obligations and FICA liability. To qualify, reimbursements must satisfy three requirements: (1) a business connection requirement (i.e., the plan must reimburse only expenses paid or incurred in connection with the employee’s performance of services for the employer, and eligible for a qualifying deduction), (2) a substantiation requirement that varies based on the type of expense, and (3) a return-of-excess requirement. For some expenses, such as travel expenses, the administrative burden of reimbursements on the employer and employees can be reduced by using per diems or other streamlined substantiation methods (e.g., mileage rates). Alternatively, employers can provide reimbursements that do not satisfy the accountable plan rules, reporting those “nonaccountable plan” payments as wages subject to income tax withholding, FICA, and FUTA.
Not all employment-related expenses made nondeductible by changes in the TCJA can be relieved by accountable plan reimbursements. For example, for the same eight-year period, the TCJA also suspended the moving expense deduction and the exclusion for employer-provided moving expense reimbursements, so those expenses cannot be deducted or reimbursed tax-free (see our Checkpoint Question of the Week). For more information, see EBIA’s Fringe Benefits manual at Sections II.E (“Employee Business Expense Reimbursements”) and XVII (“Moving Expense Benefits”).
Contributing Editors: EBIA Staff.