Accountable Expense Plans

Income Tax Service

Terry Hough

September 05, 2013 Newsletter

Accountable Expense Plans

Many employees incur personal expenses related to their job and presume that they are allowed to take a tax deduction for these items as an “employee business expense”. The IRS requires that these expenses be ordinary and necessary for your business, but it does not have to be required by your employer.

The real issue is that few, if any, people have actually ever received the tax benefit they expect because of 3 roadblocks:

the 2% of AGI limit;
alternative minimum tax;
and the itemized deduction phaseout.

The Affordable Care Act has added a 4th roadblock for the deduction - the .9% Medicare surtax.

This summary of each of these roadblocks will hopefully make them more understandable.

The 2% of AGI limit is simple to explain. It states that the employee may only deduct expenses if they are more than 2% of adjusted gross income (AGI). For example, if Ron and Mary each make $50,000, their AGI is $100,000. Two percent of $100,000 is $2,000, so if Ron and Mary’s employee business expenses are less than $2,000 in total for both of them, they receive no deduction at all, and if it is $2,800, they only get a deduction of $800.
The alternative minimum tax rule is also simple in concept. It says that taxpayers who are subject to the alternative minimum tax are not allowed any deduction at all for their employee business expense- none!
The itemized deduction phaseout rule has returned for 2013, and states that as income goes up the taxpayer loses 80% of certain deductions, including employee business expenses. This rule only affects higher income Americans, but for employees with high W-2’s and lots of business expenses it uses the gross W-2 to apply the phaseout, rather than the actual income earned after the employee business expenses.
The .9% surtax is similar to the itemized deduction phaseout because it applies to the gross W-2 without reduction by employee business expenses.

The solution is both 100% legal as well as guaranteed to save the employee with business expenses hundreds if not thousands of dollars.

As a simple example, let’s use David who is a rep for a pharmacy company. Dave’s W-2 looks huge at $250,000, but like most pharmacy reps Dave incurs $120,000 of employee business expenses and really only makes $130,000. Dave, a single guy, will owe $450 in Medicare surtax because of his inability to deduct employee business expenses, as much as $30,000 in additional AMT, will receive no actual itemized deductions because the AMT tax will most likely be higher than regular tax, but at least no itemized deduction phaseout.

So what is the 100% legal, guaranteed to work solution for Dave and every other employee in America that pays job related expenses personally?

Dave needs to run screaming down the hall to the HR department along with all other employees and demand that the employer establish an accountable expense plan.

This plan, which must be in writing from the employer, must require a business connection to the employer, must require expense submission by the employee within 60 days of spending the money, and must require the return of any excess reimbursements by the employee to the employer. If Dave’s employer has such a plan, Dave’s income is still $130,000 but Dave will owe no surtax, will wipe out the majority of AMT, and is not subject to the 2% of AGI test or the itemized deduction phaseout. Additionally Dave will get reimbursed for the expenses tax-free, be in a lower Federal tax bracket and possibly state tax bracket while saving as much as $30,000 in income tax. The only downside for Dave is that he may not be able to put quite as much in his retirement plan because of the lower gross income, butthe tax savings will more than offset this amount.

In summary, get your employer to establish an accountable expense plan and use it. It even saves the employer potential Medicare tax and worker’s compensation insurance costs.