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An accountable plan is an employer reimbursement arrangement that meets IRS requirements for business connection, substantiation, and return of excess amounts. Reimbursements paid under one are excluded from wages, so they are not taxed or reported on the employee's Form W-2. Failing any one of the requirements turns the entire payment into taxable wages.
The IRS applies three tests, set out in IRS Publication 15. Expenses must have a business connection, meaning they were incurred in performing services for the employer. The employee must substantiate them within a reasonable time with records showing amount, date, place, and business purpose. And any amount advanced beyond substantiated expenses must be returned within a reasonable time. Meet all three and the reimbursement is not compensation. Miss any one and the arrangement becomes a nonaccountable plan, so the entire payment is taxable wages subject to income tax withholding, Social Security, Medicare, and unemployment tax.
The distinction matters more than it used to. Because unreimbursed employee business expenses are no longer deductible on individual returns for most workers, an employee taxed on a reimbursement has no way to recover the tax. Employers also lose money through the extra employer payroll tax. If the employer wants the employee to keep the full amount after tax, the remedy is a gross-up calculation, which costs more than running the plan correctly.
The classic mistakes are a flat monthly car or phone allowance paid with no receipts or mileage log, and an expense process that never claws back unused advances. Either converts the whole arrangement to taxable pay, and an advance taxed as wages in one year and repaid later leaves the employee relying on a claim of right repayment. Mileage reimbursed at or below the standard IRS rate with a contemporaneous log is the cleanest example of the rules working. Several states also require reimbursement of necessary business expenses regardless of federal tax treatment.
Business connection, substantiation, and return of excess amounts. The expense must be incurred in performing services for the employer, the employee must document amount, date, place, and business purpose within a reasonable time, and any advance beyond substantiated expenses must be repaid. Failing any one of the three taxes the entire payment as wages.
Usually yes. An allowance paid without receipts, a mileage log, or a mechanism to return unused amounts does not meet the accountable plan tests, so the full amount is wages subject to withholding and payroll taxes. Reimbursing documented mileage at or below the standard rate avoids that outcome.
Generally not. Unreimbursed employee business expenses are no longer deductible for most workers on individual returns, so an employee who is taxed on a failed reimbursement has no way to recover it. Several states separately require employers to reimburse necessary business expenses, independent of the federal tax treatment.