As a result of the signing and passing of the Tax Cuts and Jobs Act (TCJA) on December 22, 2017, for tax years 2018-2025; managing employee expenses will require a bit more work. This is because for tax years 2018-2025, unreimbursed employee expenses are no longer deductible, which means that if an employee incurs an out of pocket business expense, unless the business reimburses the employee through an accountable reimbursement plan, the employee will be out of luck because claiming those unreimbursed business expenses as a tax deduction is not an option, at least not for tax years 2018-2025.
Prior to the passing of the Tax Cuts and Jobs Act, employees were able to claim unreimbursed employee expenses on the Form 2106 (Employee Business Expenses), which fell under the category of miscellaneous deductions. For tax years 2018-2025, the deduction for employee business expenses is, for lack of a better term, on an administrative leave of absence.
Employee Expense Reporting Prior to the signing of the TCJA
As mentioned previously, prior to the signing of the Tax Cuts and Jobs Act, employees were able to deduct some of their unreimbursed business expenses. Employers would sometimes reimburse employees through a reimbursement plan. Generally, the way the employer reimbursement process worked was like this; the employee incurred out of pocket expenses for business related purposes, within a certain time frame after incurring the expense, the employee was required to submit an expense reimbursement report. The relevant information on the report was the date the expense was incurred, the amount of the expense, and the business purpose of the expense. In some instances, employees could create their own expense reimbursement report by using Excel or some other software program, or simply create a table with a few columns using Word, etc. Other times, the business had a designated expense reimbursement form that employees had to use.
Using either a self-created form, or a company designated form, the employee was required to attach receipts to the form that substantiated the expenses claimed on the expense report. Usually, if the amount was less than a certain amount, such as $5.00, and there were not a lot of expenses, some employers did not give the employee a hard time if the receipt was not attached. Based on the reimbursement policy, the employer generally had a stipulated time period to issue expense reimbursement checks.
If the business had an accountable plan in place, expense reimbursements were not taxable to the employee and generally were paid to the employee on a separate check other than their payroll check. What is an accountable plan? An accountable plan is a list of guidelines that your business creates that explains how the business will reimburse an expense and which expenses qualify for reimbursement. Current tax rules do not require that the plan be in writing. However, it is a good idea that the plan be in writing and issued to employees. In order to have an accountable plan, an expense reimbursement plan, or employee advance payment plan, four conditions must be met. These four conditions are as follows;
- Business connection;
- Substantiation; and
- If an advance payment (returning amounts in excess of expense)
With an accountable plan in place, typically a business can deduct the reimbursed expenses, however, the deduction may be limited. You can read more about an accountable plan in IRS Publication 15 (Circular E) Employer’s Tax Guide. The link to IRS Publication 15 (Circular E) is:
Employee Expense Reporting for Tax Years 2018-2025 (Post TCJA Changes)
For tax years 2018-2025, your business will need to report employee expenses a bit differently than you did prior to the signing of the TCJA. Instead of employees being able to claim a portion of their unreimbursed employee expenses on their tax return, if the expense qualifies, businesses should have an expense reimbursement plan in place to reimburse the employee for qualified out of pocket business related expenses incurred. If the expense reimbursement plan that your business utilizes needs a revamping, now is a good time to revamp it. In order to reimburse an expense to an employee, your business must have an accountable plan in place, otherwise, expenses reimbursed to the employee will be considered taxable income and treated as such by the IRS.
Expense Policies and Categories Defined
Clarity relating to your expense reimbursement policy is crucial. Even though you may know what is written in the expense reimbursement policy, some of your employees may not. It is important that the employees know what the expense reimbursement policies are. After all, knowing is half the battle.
Keep the expense categories simple and easy to understand. You don’t want to include multiple expense categories in the same category. For each major expense, you should create a separate category. As it is, you have some people who just don’t like dealing with a lot of numbers. If the expense reporting policy is confusing, you might find that some employees will figure out a way to get around properly reporting the expenses. Employees doing their own thing, making up their own rules, you really don’t want that, do you?
Define, clarify, simplify, and implement the expense reimbursement policy. Doing these four things, your business should be able to implement an expense reimbursement policy that works for everyone. A win, win situation makes life for you and your employees so much simpler and less time consuming.
Granted, you don’t have to be an accounting genius or do mega research to figure out what categories to include in the expense reimbursement policy. Do like some other businesses do, just wing it. Just kidding, you don’t want to wing it, you should include general categories that satisfies IRS expense reimbursement plan requirements.
The reimbursement policy doesn’t have to be complex or multiple pages. The policy can be as simple as a single page document that clearly spells out the reimbursement policies and per diem spending limits for employees. Once finalized, each employee should be given a copy of the policy for reference purposes. Transparency, not surprises, is what employees appreciate.
Regarding non-profit organizations, because of the complexity of tax situations and special tax regulations, non-profit organizations typically end up with more expense categories than other business entities, such as an LLC or a C corporation. Keep the reimbursement policy as simple as possible, however, don’t over simplify the expense reporting.
Let’s face it, the days of keeping company records on paper filed away in filing cabinets, has become quite antiquated, to say the least. With the technological advances and electronic means, it is so much easier to keep track of company records electronically instead of on paper.
Every now and again, it would be a good idea to perform an internal audit of your company records. Doing so, will give you an idea of how well your business has been keeping track of its accounting records. This is very important because if you are ever audited by the IRS or a state taxing agency and you are missing business records, the business can be penalized for claiming expenses and deductions that cannot be substantiated. In the eyes of the IRS and state taxing agencies, this would be considered an overstatement of deductions, which will result in penalties, one such penalty would be the accuracy related penalty. 26 U.S. Code Section 6662 addresses the accuracy related penalty. You can refer to this code section at the following link:
One way to avoid running the risk of losing documents is to hop on the paperless reduction bandwagon and go paperless. Creating a digital library of receipts and other accounting related documents makes it a heck of a lot easier to store the documents, retrieve the documents when needed, and search for documents. The IRS accepts digital copies of receipts.
With the advancement of cellphone and other personal electronic gadget technology, it is quite easy for an employee to use a scanning app to digitize their receipts. Digitizing the receipts eliminates the need to have to attach paper receipts to expense reports, which can sometimes be quite tedious. Digitized documents, for both the employee, and the employer, is the way to go. Learn to work smarter, not harder.
Periodic Expenditure Reports
For various reasons, it is a good idea to run periodic expenditure reports. Addressing inaccuracies, managing business metrics, building cash flow projections and managing cash flow are all good reasons to run periodic expenditure reports.
When running expenditure reports, there are a few important things that you should look for, such as the following;
- The financial health of your business; and
- Influxes in spending and make projections
To err is human. Honest mistakes on expense reports happen. Then again, sometimes the mistakes are not so honest. Whatever the case may be, comparing an employee’s expense report with other internal expense related documentation, running an expenditure report can help you detect the error quickly.
The reality is that fraud happens, in both, large and small businesses. Generally, more often in small businesses. If you notice inaccuracies on a regular basis, especially relating to the same employee(s), that can be a sign of fraud. When it comes to employee expense reporting, fraud tends to be a big problem.
Running the expenditure report allows you the opportunity to compare employee spending with per diem limits, providing you with a bird’s eye view of fraudulent expense reporting.
Financial health of your business
It is very important for a business to understand how expenses affect the bottom line. Knowing how your bottom line is affected, you should be able to obtain a better understanding about the financial health of your business.
For some businesses, nearly 1/3 of their annual revenue is spent on travel alone. Expenditure reports allow you to put the brakes on, or at the very least, keep employee expenses within reasonable amounts.
Influxes in spending and make projections
There is a saying “failing to plan, is a plan for failure”. Running expenditure reports allows you the opportunity to compare current employee expense data with historical employee expense data. Comparing the data allows you to see if expenses have increased or decreased. Knowing this information may also give you the incentive to look at the spending habits of the business and consider budgeting for future spending.
Staying on top of employee expenditures is not an option, it is a must.