Many employers have travel reimbursement or allowance arrangements. If you want to qualify for favorable tax treatment, these arrangements must adhere to specific rules both in form and in practice. Employers who reimburse employees for travel expenses should be aware of these rules, as should their employees. Failure to comply with the rules, even by mistake, can subject both the employer and employees to significant tax trouble.

The IRS emphasized these excess-reimbursement rules under new guidance released this past month. Some tax experts predict that this guidance represents “the warning” before a new IRS enforcement blitz begins.

Reimbursement allowances

Reimbursements up to the federal per diem are nontaxable, as if they were paid under an accountable plan. Reimbursements that exceed the federal per diem rate are taxable and treated as wages. On the other hand, all payments made under a non-accountable plan are treated as wages, making the underlying expenses deductible for the employer only to the extent reasonable and deductible for the employee only as a miscellaneous itemized deduction.

The IRS requires that all payments made under an abusive arrangement be treated as made under a non-accountable plan. Unfortunately, employers don’t have to stray far from the rules to have what the IRS considers “an abusive arrangement.”

Abusive plans

For periods ending on or before December 31, 2006, the IRS has instructed its auditors to only treat the excess amounts as wages, not the entire reimbursement, unless there were egregious circumstances or evidence of intentional noncompliance. After December 31, 2006, auditors were instructed to tax only the excess unless the plan is "abusive." "Abuse“ is measured according to:

1. whether the employer routinely makes payments in excess of the federal per diem rate and
2. whether the employer has a system in place that tracks the excess travel reimbursement amounts (and, if so, whether the employer treats the excess amounts as wages).

If the employer has a system in place, then the fact that the employer, due to system errors, fails to treat excess payments as taxable will not be considered a sign of abusive behavior. This “safe harbor” will apply even if the excess payments have been made routinely during such system’s error.

If you’d like a check-up of your T&E reimbursement policy and systems, and an evaluation of how they conform to the current restrictions, please feel free to call our office.

(SBSE-04-1106-049)