What is a Non-Accountable Plan
A non-accountable plan is a way to provide employees with an allowance for business expenses or travel that does not need to be justified to an employer. Money provided to employees in a non-accountable plan is considered taxable income and should appear on an employee's W-2. Also known as an allowance plan, non-accountable plans differ from accountable plans in that the latter requires employees to provide adequate accounting to receive reimbursement. Since money received by employees under an accountable plan is for reimbursement of money spent on business-related expenses it is not taxable.
Breaking Down Non-Accountable Plan
While money given to employees under a non-accountable plan is meant to be spent on business expenses, such as travel, meals or entertainment, the recipient may spend it any way they choose. For example, if an employer were to give an employee $500 to cover the cost of meals while away on a business trip, under a non-accountable plan, the employee could eat inexpensive food for every meal and pocket the savings. As far as how the Internal Revenue Service (IRS) is concerned, it is compensation that is paid in addition to salary or wages. As such, it is taxed as income. Employers may use a non-accountable plan for some expense items and an accountable plan for other expenses.
Non-Accountable Plan: Expenses and Tax
Any outlay on business-related expenses in a non-accountable plan may be claimed as a miscellaneous itemized deduction by the recipient on their 1040 Form. Such expenses are subject to a 2% limitation that dictates that filers who itemize may only deduct the part of the expenses that exceeds 2% of their Adjusted Gross Income (AGI).
As per IRS rules, expenses must be both "ordinary and necessary" to be deductible, otherwise the IRS may deny then or consider them "lavish" and also not allow them, though this is rarely applied. In the context of non-accountable plans, "ordinary and necessary" has a more lax definition depending on the context. "Ordinary" simply means something that is typically needed in the operation of a business. "Necessary" merely means an item is appropriate and helpful in the operation of a business. For more, see IRS Topic Number 514: Employee Business Expenses.
Non-Accountable Plan vs. Accountable Plan
In an accountable plan, the employee must substantiate what the expense was and what it was for, how much it was, and that it was incurred while doing business for the company. Accountable plan expenses are not considered taxable income. Any advances not used must be returned to the company in a timely fashion (as specified by the IRS).