January 1, 2013 was the effective date for numerous Federal tax provisions geared towards raising additional tax revenue. This article will discuss one tool that may be used to reduce the additional tax burden of these new provisions.
What is an accountable plan?
An accountable plan (“plan”) is a reimbursement or other expense allowance arrangement that allows employees to be reimbursed tax free for business expenses they paid personally. The requirements for a plan to be classified as an “accountable plan” are specific; but in general, the plan must only pay for deductible business expenses, maintain adequate substantiation, and require employees to return excess advances. This type of plan allows the employer to deduct the amounts disbursed as business expenses and allows the employee to exclude the reimbursements from taxable compensation.
Benefit to employee
The reimbursements for the business expenses are not considered taxable compensation, so employees are not required to pay payroll or income taxes on the reimbursements.
Employees who are not reimbursed for business expenses usually claim the expenses as deductions on their individual income tax returns. Whether they know it or not, most employees do not receive the full tax savings by deducting the expenses on their individual income tax returns due to deduction limitations and the alternative minimum tax.
Benefit to employer
The reimbursements are deductible expenses for the employer. Because the plan reimbursements are not considered employee compensation, the employer benefits by excluding the reimbursements from employer payroll taxes and workers’ compensation insurance premiums.
Tax Savings Example
Without an Accountable Plan
A physician signs an employment contract with guaranteed wages of $300,000 but is responsible for paying for his/her business related cell phone, dues, CME, and related travel out of his/her own pocket. If these amounts total $5,000, the physician may claim these items as deductible business expenses but will receive no tax benefit or savings from doing so. This is because unreimbursed employee business expenses are deductible only when the amounts exceed 2% of their adjusted gross income. If the physician’s only income is from wages, the first $6,000 of unreimbursed expenses is not deductible ($300,000 × 2%). The unreimbursed employee expenses, along with any other Schedule A miscellaneous deductions must exceed $6,000 before there is any tax benefit for the out of pocket expenses.
Even if these items do exceed the 2% adjusted gross income floor, many physicians end up paying alternative minimum tax, and these expenses are not deductible when calculating the alternative minimum tax. Under this scenario, the physician will not receive any tax reduction for the business expenses paid by him/her.
With an Accountable Plan
As an alternative, the employer could maintain an accountable plan. The physician could sign an employment contract with guaranteed wages of $295,000 and an accountable expense reimbursement plan up to $5,000 per year to be used for his/ her business related cell phone, dues, CME, and travel. The guaranteed salary combined with the expense reimbursement is the same $300,000. Because the expense reimbursement is not taxable income to the employee, the tax savings will result from reduced Federal, state, and local income taxes. Depending on the physician’s tax bracket, this could be a potential tax reduction of $2,000 or more per year.
Furthermore, the employer will not be required to pay employer payroll taxes or workers’ compensation insurance on the expense reimbursements. If the practice utilizes the plan on multiple physicians or other employees, the practice can obtain significant tax savings in exchange for complying with the requirements.
Many practices may have accountable plans already in place. For practices and employers without a documented plan, strong consideration should be given to implementing a plan. Employee physicians should also consider discussing such plans with their employers or potential employers for their personal benefit.
Additional reporting from L. Porter Roberts, Jr. and Harvey D. Thompson
An accountable plan (“plan”) is a reimbursement or other expense allowance arrangement that allows employees to be reimbursed tax free for business expenses they paid personally
L. Porter Roberts, Jr., CPA, Matthew S. Smith, CPA, CFE, and Harvey D. Thompson, CPA, CVA, CMA, are with the Medical Services Group of Barr, Anderson & Roberts, PSC, in Lexington, KY. If you would like more information, they can be reached via email at lproberts@barcpa.com and msmith@barcpa.com and hthompson@barcpa.com and via telephone at 859-268-1040.