Your not-for-profit can’t generally reimburse employees for business expenses tax-free just because staffers submit expense records. However, you can if you have a properly executed accountable plan. Under such a plan, reimbursement payments will be free from federal income and employment taxes for recipient employees and not subject to withholding from their paychecks. Additionally, your organization benefits because the reimbursements aren’t subject to the employer’s portion of federal employment taxes.
Follow the rules
Of course, rules and conditions apply. The IRS stipulates that all expenses covered in an accountable plan have a business connection and be “reasonable.” Additionally, an employer can’t reimburse an employee more than what he or she paid for any business expense. And the employee must account to you for his or her expenses and, if an expense allowance was provided, return any excess allowance within a reasonable time period.
An expense generally can qualify as a tax-free reimbursement if it could otherwise qualify as a business deduction for the employee. For meals and entertainment, the plan may reimburse expenses at 100% that would be deductible by the employee at only 50%.
It’s your organization’s responsibility to identify the reimbursement or expense payment and keep these amounts separate from other amounts, such as wages. The accountable plan must reimburse expenses in addition to an employee’s regular compensation. No matter how informal your nonprofit, you can’t substitute tax-free reimbursements for compensation employees otherwise would have received.
Keep good records
The IRS requires employers with accountable plans to keep good records for expenses that are reimbursed. This includes documentation of the:
- Amount of the expense and the date,
- Place of the travel, meal or transportation,
- Business purpose of the expense, and
- Business relationship of the people entertained or fed.
You also should require employees to submit receipts for any expenses of $75 or more and for all lodging, unless your nonprofit uses a per diem plan.
Put it in writing
While an accountable plan isn’t required to be in writing, formally establishing one makes it easier for your nonprofit to prove its validity to the IRS if ever challenged. Contact us for more information and help setting up an accountable plan.