S-Corps Accountability Plan for Out of Pockets Business Expenses
Accounting and taxes get more complicated when you are self-employed, especially when S-Corp business expenses get intermingled with personal expenses. If you do not declare these expenses properly, which are typically mixed-use expenses, you might lose these deductions and your tax liability will increase. If done in the right way, it is possible to reduce your total tax bill. S-Corporations need to use an “Accountable Plan” to ensure that the shareholder's tax consequences are minimized.
The Accountable Plan
It is essential for an S-Corp to create and follow an Accountable Plan. An Accountable Plan allows tracking of all the business expenses linked to personal expenses (such as home office, cell phone usage, internet use etc.), which are to be reimbursed by the business. The expenses are typically mixed-used in nature. Expenses that are 100% business use can also be reimbursed but ideally these should be paid directly by the business.
With an accountable plan, it is possible to bring down the company profits, by providing for reimbursements to be paid out for expenses by shareholders. Doing this can also bring down the total amount to be paid for Social Security as well as for Medicare taxes (depending on how the company is allocating between w-2 wages and shareholder distributions).
Should you choose to reimburse without using an Accountable Plan, the reimbursed amount can be disallowed by the IRS. The alternative (less appealing) approach is that the expenses be taken as a miscellaneous itemized deduction (more specifically an unreimbursed employee business expense) on Schedule A of the 1040. This is not ideal because Misc. itemized deductions are subject to a 2% AGI limitation (reducing your deduction) and some taxpayers will not be itemizing deductions (making this deduction useless).
Accountable Plan Must-Haves
For expenses to qualify under the Accountable Plan they must have a connection with the business, meaning they should be incurred while working for the S-corp. The plan should have detailed conditions that outline how reimbursement is done, and the parameters that guide the reimbursement. When it is richly detailed, the plan has a better chance to pass muster.
The accountable plan is a document that outlines company policy, and it applies to all the employees in the business (if you have any additional employees). The expenses must be properly accounted for by the employee/shareholder, and this should be done in a timely manner (i.e. 60 days). Accompanying paperwork including receipts, invoices and supporting documentation should be kept on file.
When done properly, an accountable plan makes it possible to maximize business expenses and bring down your overall tax liability.