What an accountable plan is
When an employer reimburses an employee for business expenses, the payment is either excluded from the employee's income or it is wages. The dividing line is whether the reimbursement arrangement is an accountable plan. IRC § 62(a)(2)(A) and § 62(c) set the rule, and Treas. Reg. § 1.62-2 spells out the mechanics.
Under an accountable plan, reimbursements are not reported on Form W-2, are not subject to federal income tax withholding and are not subject to Social Security, Medicare or federal unemployment tax. Under a nonaccountable plan, every dollar is treated as supplemental wages. For a company that reimburses millions in travel each year, the difference shows up directly in payroll tax cost and in employee take-home pay.
There is no form to file and no IRS approval to obtain. A plan is accountable because of how it is written and, just as important, how it is enforced. That is why the expense audit process, not the policy document alone, is what auditors look at.
The three requirements
Treas. Reg. § 1.62-2(c) requires the arrangement to meet three tests. Failing any one of them for a given payment moves that payment into wages.
Result when all three hold
Reimbursements excluded from wages: no withholding, no FICA, not on Form W-2
Business connection
The expense is deductible business spend the employee paid or incurred while performing services for the employer.
Is there a stated business purpose?
Substantiation
Amount, time, place and business purpose are documented within a reasonable period. Safe harbor: 60 days.
Receipt for lodging and anything $75 or more?
Return of excess
Any advance or allowance above substantiated expenses is returned within a reasonable period. Safe harbor: 120 days.
Is every unspent advance tracked to repayment?
Foundation: a written reimbursement arrangement, applied consistently to every employee
1. Business connection
The reimbursement must be for expenses that are deductible business expenses the employee paid or incurred in connection with performing services as an employee. A reimbursement for a personal weekend extension of a business trip, a spouse's airfare or an in-room movie fails this test for that amount.
2. Substantiation
The employee must give the employer enough information to identify the specific business nature of each expense and substantiate each element. For travel, meals, gifts and listed property the elements come from Treas. Reg. § 1.274-5: amount, time, place and business purpose, plus the business relationship of the people involved for meals and gifts. A card statement line on its own is not substantiation because it does not show what was bought or why.
3. Return of amounts in excess of expenses
Any advance, allowance or reimbursement that exceeds substantiated expenses must be returned within a reasonable period. An employer that lets employees keep unspent advances has, for those dollars, a nonaccountable plan.
The 60 and 120-day safe harbor
"Reasonable period" depends on facts and circumstances, but Treas. Reg. § 1.62-2(g) gives two safe harbors. Most companies write the fixed-date method directly into their expense policy.
| Event | Fixed-date method | Periodic statement method |
|---|---|---|
| Advance paid | No more than 30 days before the expense | Reasonably calculated not to exceed expected costs |
| Expense substantiated | Within 60 days after paid or incurred | Within 120 days after receiving the statement |
| Excess returned | Within 120 days after paid or incurred | Within 120 days after receiving the statement |
| Employer obligation | Enforce the dates | Send statements at least quarterly listing excess amounts |
In practice the fixed-date method is easier to audit: every line on every report has a clock that starts on the transaction date. A report filed on day 74 for a dinner on day 0 is outside the safe harbor even if the trip itself ended recently, so the audit has to work at the line level, not the report level.
The $75 receipt rule
Treas. Reg. § 1.274-5(c)(2)(iii) requires documentary evidence, such as a receipt or paid bill, for any expenditure for lodging and for any other expenditure of $75 or more. For expenses under $75, other than lodging, an adequate record (an expense report entry with amount, date, place and business purpose) is enough.
- Lodging always needs the itemized hotel folio, whatever the amount, because the folio is what shows room charges separately from meals, minibar and other incidentals.
- The $75 test applies per expenditure. Two $41.30 meals at the same restaurant on the same evening for the same group look like one $82.60 expenditure split in two.
- A credit card slip showing only a total and tip proves payment but not what was bought; for meals with alcohol or attendees it is rarely enough for internal policy.
- Many companies set a lower internal threshold, such as $25, for alcohol, gifts or any spend charged to government contracts.
Per diem substantiation
A per diem allowance replaces actual receipts for lodging, meals and incidentals. Under Rev. Proc. 2019-48, when an employer pays a per diem that does not exceed the federal rate for the locality and the employee substantiates the time, place and business purpose of the travel, the amount of the expense is deemed substantiated.
Employers can use the federal per diem rates published by GSA for the continental US and by the Defense and State Departments elsewhere, or the IRS high-low method, which applies one rate to a published list of high-cost localities and a lower rate to everywhere else. The rates update every October.
If the per diem is higher than the federal rate and the employee is not required to return the excess, the amount up to the federal rate is reported in box 12 of Form W-2 with code L and the excess is wages subject to withholding and FICA. Employees still need receipts for lodging when only an M&IE per diem is paid.
When reimbursements become wages
Payments that fail the requirements are treated as made under a nonaccountable plan. They are included in the employee's gross income, reported in box 1 of Form W-2, and subject to federal income tax withholding and to FICA and FUTA. The employer owes its share of payroll tax and, if withholding was missed, can be liable for the employee share too.
| Treatment | Accountable plan | Nonaccountable plan |
|---|---|---|
| Employee gross income | Excluded | Included |
| Form W-2 box 1 | Not reported | Reported as wages |
| Federal income tax withholding | None | Required (supplemental wage rules) |
| Social Security and Medicare (FICA) | None | Employer and employee shares due |
| FUTA | None | Due |
| Employee deduction for the expense | Not needed | Generally unavailable to W-2 employees since 2018 |
The last row is what makes this painful for employees. Since the Tax Cuts and Jobs Act suspended miscellaneous itemized deductions, most W-2 employees cannot deduct unreimbursed business expenses, so a reimbursement that becomes wages is simply taxed with no offset.
One undocumented dinner moves one dinner into wages. A plan that never enforces its own deadlines risks the regulations' pattern-of-abuse rule, under which every payment under the arrangement can be treated as wages.