With 2018 ending, employees with significant unreimbursed expenses are almost out of time to renegotiate their expense reimbursement terms. The Tax Cuts and Jobs Act removed the ability to deduct all miscellaneous expenses subject to a 2% limitation, including unreimbursed employee expenses. For most taxpayers, this isn’t an important change, but for a small minority, particularly salesmen, this can be a VERY IMPORTANT change. Salesmen aren’t the only ones potentially feeling the effect of this change. Emergency personnel, such as firefighters and law enforcement, are often required to supply or supplant their own equipment, resulting in significant unreimbursed expenses.
Under the old law, if an employer maintained a policy of not reimbursing an employee for expenses they incurred, the employee could add those expenses to their itemized deductions. Similarly, if an employer maintained a non-accountable reimbursement plan, where an employee’s wages were increased for expense reimbursements, the employee could deduct the actual expenses incurred. This deduction allowed employees to only be taxed on their net income after expenses, instead of their gross receipts. In practice, between deduction thresholds and the need to itemize deductions to obtain any benefit, the result was less than ideal, but more equitable than if no deduction were allowed.
The new law eliminates this deduction, leaving employees without employer reimbursements, or with non-accountable plans, paying income tax on their gross receipts. For an outside salesperson who puts over 50,000 miles on their vehicle and spends thousands on entertainment to pursue clients, this can be a big difference in take home pay. The only way to alleviate this result is to negotiate a new employee expense reimbursement arrangement, but with the year ending, time is running out for 2018.
Ideally, an accountable reimbursement plan could be set up, where an employer directly reimburses an employee for expenses based on receipts provided. The reimbursement isn’t income to the employee and is considered an expense of the employer. However, accountable plans require more effort to maintain, and many smaller employers don’t want the administrative hassle. Alternately, a non-accountable plan can be grossed up to a larger reimbursement, adjusting for the tax the employee would need to pay on the reimbursement, makeing them whole. Failing that, a simpler, but less exact, method could simply be a pay raise. If you would like to discuss how the new unreimbursed expense rules apply to your situation, please feel free to reach out to us for a consultation.
Written by Damien Falato, CPA, MST, CGMA, Tax Director