How Should S-Corps Reimburse Employees and Deduct Expenses?

How Should S-Corps Reimburse Employees and Deduct Expenses?

Contact Us

Many small business owners are familiar with deducting their business expenses when operating a sole proprietorship or general partnership. But what about an S-Corp? As you may know from our previous article, S-Corps have huge tax saving benefits, but they use a pass-through income structure where owners are considered shareholder-employees, which complicates expense deductions slightly. The IRS provides a way for S-Corps to deduct employee-paid expenses by passing employee expenses on to the S-Corp through something called an Accountable Plan.

What is an Accountable Plan?

An Accountable Plan is the IRS’s formal and streamlined way to convert deductible business expenses from an employee to the business. It is a reimbursement plan that is set up by the business, in this case an S-Corp, which reimburses employees for their personally paid business expenses, and in turn, deducts these reimbursements on the small business’s taxes.

Although an Accountable Plan isn’t required for an S-Corp, it really should be considered a business necessity, since it allows owners and the S-Corp to maximize their deductions. An Accountable Plan isn’t particularly difficult to set up or maintain. In fact, it can be established pretty much instantaneously, but the IRS does have some specific rules and requirements for operating an Accountable Plan, which we’ll outline and explain below.

What are the Three IRS Rules for an Accountable Plan?

  • Expenses must have a business connection.
  • An Employer (the S-Corp) must require that any expenses to be reimbursed be substantiated to the employer within a reasonable period of time.
  • Any amounts initially paid to an employee in excess of what the employee ultimately substantiates to the employer generally must be repaid within a reasonable amount of time.

What does “Business Connection” Expenses Cover in an Accountable Plan for an S-Corp?

It really is as straightforward as it sounds, but can get a little more convoluted, especially for small businesses and employee-owners who are pretty much reimbursing themselves. If an expense is reimbursable, it must have a direct tie to the business. Purchasing office supplies for the store? Reimbursable. Going out of town and also happen to get dinner with a business connection while you’re there? Trickier.

Business connection means it has to have a direct tie to the business, but when we’re talking about travel expenses for instance, it also has to be the reason for the trip.

Example of What Qualifies “Business Connection” for an Accountable Plan Expense

Daniel owns a used car lot, operating as an S-Corp. He goes out of town to attend his son’s wedding in Arizona. While he’s there, he meets a guy who sells used car parts and they go to dinner to discuss doing business together. Under Daniel’s business’s accountable plan, he can be reimbursed for dinner since it was a clear business meeting. However, even if he does end up going into business with the guy, he can’t be reimbursed for his travel expenses since the purpose of the trip was his son’s wedding, not business.

What does “Substantiating Expenses to the Employer in a Reasonable Period of Time” Mean for an S-Corp Accountable Plan?

How to Substantiate Expenses?

Substantiating simply means providing proof of the expense and proof that it is reimbursable. This proof is provided by the employee to the employer, which may seem redundant for S-Corp employee-owners, but these records should still be kept. What defines this proof isn’t necessarily definitive, but it should be enough for the employer to determine the nature of the expense and if it is reimbursable. Keeping receipts from all reimbursed expenses is good practice.

Certain categories of expenses do have more requirements for substantiation. As we said, keeping all receipts is good practice, but they are required for lodging and any other expense over $75.

Additionally, business gifts, business travel (including meals and lodging), and the use of certain “listed property” requires that the substantiation include:

  • The amount of the expense
  • The time and place of the travel, or a description of the gift
  • The business purpose of the expense
  • The business relationship to the person receiving the benefit

A receipt for one of the above expenses may provide some of these details, but not all. So for these specific types of expenses, extra information and proof should be provided to and held by the S-Corp.

What is a Reasonable Time Period?

The last portion of this requirement is determining what is a reasonable time period for providing the substantiation. The IRS gives two fail-safe options that an S-Corp owner can choose to utilize.

The first is requiring substantiation within 60 days of when the expense was originally paid for by the employee. The second option is that the S-Corp may provide a quarterly report of any expenses that were reimbursed but not yet substantiated to the employee. After which, the employee must provide substantiation within 120 days or pay back the reimbursed amount. Using either of these options will qualify as a “reasonable time period” in the IRS’s eyes.

What Does “Excess Amounts Must be Paid in a Reasonable Amount of Time” Mean for an S-Corp Accountable Plan?

The last requirement essentially means that if an S-Corp fronts an employee’s expenses or pays reimbursement before receiving substantiation, then the employee must pay back any excess received in a timely manner. An example of this could be if an S-Corp owner takes a business trip and does not want to use his personal funds, so he withdraws a lump sum from the S-Corp for the trip. After he returns and tallies up his receipts from the trip, he must make a timely return of any excess amount from the original withdrawal back to the S-Corp.

Again, the IRS does give another fail-safe option on what qualifies as timely. The advance should be given no more than 30 days before the expense is paid or incurred and any excess repaid within 120 days of the same date.

Wrapping It Up

An Accountable Plan is an excellent method for S-Corps to still deduct employee expenses and even take advantage of S-Corp owner deductions that they otherwise would not be able to. But it’s important to follow the IRS rules to make sure you don’t end up creating more headache for yourself. Our CPA Firm specializes in small business taxes and s-corp accounting, and we’re here to keep all of your bookkeeping running smoothly, while saving you the most money on taxes. Give us a call!

Categories: tax