Did you know that you can no longer write off miscellaneous itemized expenses? That’s because of the Tax Cuts and Jobs Act. Toby Mathis talks about how to take personal expenses that are not deductible and make them reimbursable business expenses that you don’t have to report as taxable income.
Highlights/Topics:
- Identify expenses that may not be deductible to you as an individual, but to a business; expenses that benefit a business that you incur personally as an employee
- How businesses are structured (sole proprietorship, partnership, corporation, etc.) and operate affects personal expenses for business
- Accountable Plan – Reimbursements and Expense Allowance Arrangement: Amounts paid are excluded from employee’s gross income, not reported as wages/compensation
- Keep a paper trail; document who, what, why, when, and where you’re writing off
- Four-part Test:
- Is there a business connection to the expense?
- Substantiation: Can you provide proof (i.e. a receipt) to the employer proof that you incurred the expense?
- No Excess Payments: It can reimburse you what you paid. But, can it give you extra money?
- Timeliness: Do you let the employer know of expenses every 90 days, for the employer to reimburse you within 120 days?
- Examples of expenses that you might get reimbursed on include travel to and from the hotel and business meals
- Employee Home Office – Four ways for a home office deduction, if you:
- Are an employee doing administrative activities at home, it qualifies as a principal place for business.
- Have a cash register for your business, or transacting business and collecting money in your home.
- Have a physical place where you meet patients, clients, customers, or whatever.
- Have a detached structure that is not part of or attached to the dwelling unit.
Resources
Tax and Asset Protection Event
Full Episode Transcript:
Hi guys. Toby Mathis here. Today we’re going to be talking about how you can take expenses that you’ve incurred personally, that are not deductible, and are hereinafter gone because we’re not even going to be able to write off miscellaneous itemized expenses anymore since they removed from the Tax Cuts And Jobs Act, but how we can take those expenses that we don’t get to write off and how we can make them reimbursable business expenses that we can receive reimbursement from a business. It can write it off and I don’t have to report it as taxable income. Yeah, you heard me right.
The first thing we have to do is figure out what exactly we’re talking about, what rules actually impact it. We’re talking about deductible expenses that may not be deductible to you as an individual but would be deductible to a business. That’s kind of step number one. Are these related to business? Are they something that a business could say it’s for their benefit even though you’re incurring them personally?
That presumes, of course, one major fact which is that you’re an employee of the organization. Here’s why this is important because as an individual owner of a business, you have several choices as to how you structure that. 70% of businesses out there just set themselves up as what’s called a sole proprietor, which means they do nothing except report the income taxes or the business income and expenses on their Schedule C of their 1040. In other words, it’s going on to the personal return and they are just filing a schedule on their personal tax return. That’s how 70% of the businesses out there operate.
Now, the problem is, is you cannot be an employee of your own sole proprietorship, so you are not eligible for what I’m talking about. What I’m talking about today is specifically termed an accountable plan. It falls under a set of federal regulations or what we kind of call the tax laws, which should be 1.162-2, a section that is Reimbursements and Expense Allowance Arrangement.
This is exactly what it says. “Amounts treated as paid under an accountable plan are excluded from the employee’s gross income and are not reported as wages or other compensation on the employee’s Form W-2. They are exempt from withholding and payment of employment taxes,” which is like FICA, FUTA, Railroad Unemployment Act, all sorts of fun stuff, and income taxes.
In other words, you don’t pay any tax on it. You don’t have to report it. It doesn’t show up on your 1040 at all. Now, the business gets to write it off as a business expense but it doesn’t sit there and call it wages or other compensation to you. It’s just reimbursement under an accountable plan.
So, the first hurdle is to make sure that you’re an employee. If you can’t do that as a sole proprietor, then what are our other choices? A lot people look and they’re set up as partnerships, which basically is two sole proprietors. If it’s individuals, you can’t be an employee of your own partnership either. That leaves us to really just one choice which is a corporation.
There’s a couple flavors of corporations, S or C corps or even nonprofits. But still, it’s just going to be a corporation. That’s how you become an employee. If you want to have the benefit of the accountable plan, the most important thing is to make sure that you’re set up correctly. Just knowing the facts out there, 70% of you could not do it even if you wanted to, and it’s closer to 80% when you had a number partnerships out there. So, 80% of the businesses don’t even qualify for this because they are not set up properly. Of that 20% then you just have one other hurdle, which is to meet some requirements set out in the code.
Here’s the beautiful part. Technically, you don’t even have to have an accountable plan in writing, although I’ll just tell you as an attorney and as a tax practitioner, you want to make sure that you have things in writing because when the IRS comes in, they’re just going to say, “Where is your backup for any of these expenses?” and they want to know the who, what, why, when, and where that you’re writing off.
The regs do give us the kind of a safe harbor of things that we can pass or that we can keep to make sure that we never have to worry about having these expenses be excluded and treated as taxable income to us. If they’re not a reimbursement under an accountable plan, then they’re wages. We want to make sure that we don’t fall into that category. The easiest way to do that is to just keep a paper trail.
Now, assuming that you’re set up correctly, you’re set up as a corporation, and by the way, this could be an LLC taxed as a corporation. It could be an S corp, a C corp, LLC taxed as an S corp, LLC taxed as a C corp. As long as you’re an employee, which means an officer, a director, even if you’re not even taking a wage, you can still be considered an employee, and you have an accountable plan, which basically just says the business is going to reimburse any expenses that you incur—I’ll go over a few of them here in a second—then your next hurdle is to make sure that said that you meet the four-part test that they give.
Realistically, the four-part test that’s set up in the regs, really simple. Is there a business connection to the expense? In other words, it’s not going to reimburse you for groceries. It’s going to reimburse you for things that you’re using in conjunction with the business. For example, if you’re using a cellphone and the business says, “Hey, we need to have access to you 24/7 or we need you do be able to talk to customers and we need you to have a cell phone,” then it can reimburse you for the full cost a that cell phone. That’s pretty straightforward.
Before you freak out and say, “What about my personal use?” That’s not important here. It’s whether it’s for the benefit of the employer and is that cell phone being used in connection with the business, then it can reimburse you 100%. It’s 100% deduction. For those of you who are sole proprietors, your eyes are rolling around going, “Wait a second. I have to track business and personal use.” Yeah, you do but not under an accountable plan. That’s why it makes sense sometimes this structure yourself a little differently.
Number two is substantiation. You have to provide the employer proof that you incurred the expense, so a receipt. Again, I always say keep a who, what, where, when, and why. Use a credit card so it’s easy to track and then say, “Here’s what I incurred that for.” Cell phones are pretty easy. You just show the payment that you made.
Then number three, no excess payments. It can reimburse you what you paid. Not a whole bunch of extra money. If you incur $100 worth of expense, the business doesn’t pay you $130. It pays you $100. If it pays you $130, then the $100 of the reimbursement is treated as under the accountable plan and is not taxable. The excess payment, the $30 should be treated as wages.
And then timeliness. They want you to be tracking these things. Generally speaking, they want you to let the employer know of the expense every 90 days and for the employer to reimburse you within 120 days. Obviously, if the employer does not have a bunch of cash, then you’re going to have to perhaps move that into a note or something else. You just want to make sure that you’re keeping track of these expenses and letting the employer know. I suggest that you do it at least on a quarterly basis. Again, this is a safe harbor. This isn’t a hard and fast rule. This just says, “Hey, if you do this, we’re not even going to question it.”
What are examples of some expenses that you might get reimbursed on? Well, travel might be one. You’re traveling around on behalf of the business or you have a business that has an element to it that benefits when you’re traveling. So, you’re going out to some trade shows, maybe some seminars or conventions where you’re going out to meet some clients, or if you’re in real estate, maybe you’re looking to real property, things like that. The travel expense would include the travel to and from the motel or hotel, business meals.
A lot of folks say, “Well, they’ll only get you to write off 50%.” Well the business only gets to write off 50%, it could certainly reimburse you for meals when you’re on the road or when you’re meeting with clients, and things like that. Or you just get a credit card in the company name but we’re just talking about the accountable plan and reimbursing right now so assume that you paid for it, then you can reimburse yourself.
The way it works is this: I always use the example of my employer calls me and says, “Bring in 12 dozen Krispy Kreme doughnuts for the office,” something like that, or just says, “Hey, go out there and go buy a bunch of doughnuts, bring it in here and we will reimburse you,” I come in, I give the receipt, let’s say it’s $100, and the company reimburses me. I don’t report that anywhere as a person. I don’t have to say, “Hey, company reimbursed me $100,” I don’t have to show that anywhere.
Where it really comes into play is for the company. They want that receipt so they could say, “Hey, we incurred an expense, bringing in a bunch of doughnuts for our convenience or for a representation or what not,” maybe they’re doing the customer thing, and data show that as a regular office expense, and you don’t have to report it anywhere.
That’s how these things work. It’s pretty much a very, very shallow paper trail of anything. It’s just a receipt. As long as you’re meeting the same requirements that you’d have to meet if you want it to write it off anyway, then you’re absolutely fine.
Other example is, let’s say the employee or let’s say you’re buying an iPhone or some computers or something for the business, say your kids work in the business, too, that type of thing, then the business can just reimburse you for that.
One of the big ones is the employee home office. A lot of practitioners out there just don’t understand the home office. It’s actually pretty simple. When you look at it, there’s really only four ways that you’re gonna have a home office deduction and they always seem to get stuck on one. But if you are an employee and your doing your administrative activities at your house, that qualifies as a principal place for business. It sounds weird but it’s easier as an employee to have a home office than it is if you’re just trying to run your business.
The other three ways to do it is if you actually have a cash register in your business, in your home, or where you’re transacting all the business and collecting all the money, then that works too. Or if you have a physical place where you’re meeting patients, clients, customers, or whatever, that obviously qualifies. Or if you actually have a detached structure that is not part of the dwelling unit, not attached to the dwelling unit, and that’s where you run your business. Those are kind of the four ways.
The easiest one obviously is the administrative office which again, that’s the one everybody seems to miss, and all of a sudden the business can reimburse you for the cost. That cost is everything associated with that house including your utilities, internet, house cleaning, all that stuff gets lumped in the depreciation. You actually calculate out if you are depreciating the improvement on it and you calculate that as an expense. Any mortgage payments or private mortgage insurance, all these things get added in and you come up with a total amount for running the home. Then you figure out what percentage you’re using of the house.
Now, there’s 10 different ways to calculate the percentage of business use that should be exclusively used for the business. You actually want to have a room set aside for your business, where you say, “This is where I do all my administrative activities for my business.” The beautiful part about that is when you established an office away from your main office perhaps, then the travel between those becomes business miles instead of commuting miles you can actually reimburse yourself even if you’re driving from one office to the other. The company can actually reimburse you and you don’t have to report that income either.
But there’s about 10 different ways to calculate out what percentage of those expenses you calculate. A lot of people use the square footage, where they look at the total square footage of the house and they say, “This is how much the room is,” and they divide that and come up with a percentage. Let’s say you’re using 10% of the house for the business room. Then you would get 10% of the expenses as a reimbursable expense. You can reimburse yourself 10% of the total cost for the year. So, if $30,000 a total cost, you can reimburse yourself $3000. You don’t have to report it and the company will report it as office expense. That’s not a huge percentage.
The other methodology you can use is net usable square footage. You look at the office compared to the rest of the space of the house excluding hallways, bathroom, things like that, and you come up with a net usable square footage, and you might get up to 20%. The other route you go is if there’s actual rooms in the home and they’re fairly equivalent in size.
Let’s say you have a house that has a big living room and four Sub rooms, whether they be bedrooms or whatnot. We’re not going to count bathrooms, obviously, but we’re going to look at the rooms. Let’s say we we have a five-room home total and one of those is being used for business, then you have 1/5 or you have a 20% deduction. That sounds like a pretty decent amount.
Again, let’s go back to our same example of $30,000 total expense. You can reimburse yourself up to $6000. You don’t have to report it but the business deducts it. That’s a nice fat tax benefit and that what comes underneath the accountable plan.
For the folks that know what they are, they’re extremely, extremely powerful. For folks who don’t know what they are, well they’re missing out, so you want to sometimes tap them on the shoulder and say, “Hey, you’re missing out. If you’re going to be in business, you may as well get some benefits.”
Anyway, that was it for today. I just want to go over accountable plans and give you some easy ways to create an accountable plan, making it basically bullet-proof is to make sure that you set up is the right structure, you’re going to end up being a corporation, you’re going to be an employee of that organization, and then just want to make sure that there is a business connection for the expense, that you substantiate it with some sort of evidence, and you don’t pay yourself more than you actually paid as an individual. You don’t reimburse yourself more than you paid and that you try to be doing it every quarter at a minimum and you will have no issues. It makes life a lot easier as well.
