Employees may deduct out pocket business expenses incurred in their employment. These costs are often deducted as itemized expenses. However, itemizing out of pocket expenses present significant disadvantages that reimbursement plans may mitigate.
Limitations on Itemized Deductions
The Internal Revenue Code limits itemized deductions for most out of pocket business expenses. Various code provisions also have built-in limitations. Aside from these built-in limitations, only expenses exceeding 2% of Adjusted Gross Income (AGI) may be deducted as itemized expenses. This “2% of AGI floor” can present significant disadvantages.
Taxpayers often elect the Standard Deduction to obtain a more enhanced tax benefit. This is primarily because most taxpayers do not have sufficient itemized deductions to exceed the Standard Deduction and other dependent deductions. Therefore, taxpayers will not elect to itemize their deductions, but rather, take the more advantageous Standard Deduction. When the dust settles, out of pocket business expenses are never deducted.
Reimbursement Plans Can Enhance Deductions
A business entity, such as an S-Crop., can overcome these drawbacks. By creating an Accountable Reimbursement Plan, shareholder-employees may be reimbursed by the corporation for out of pocket business expenses. The corporation receives a deduction for reimbursable payments made to shareholders since these payments are a “business expenses.” This reduces the amount of taxable income flowing through to each shareholder at the end of the taxable year. The reimbursement payments themselves are non-taxable.
The Reimbursement Plan avoids the 2% of AGI floor limitation as well as the overall limitation on itemized deductions. This makes it an ideal option even for those taxpayers electing to itemize deductions.
Contact Tax Attorneys at Randhawa Hundal LLP to Learn More!
Our Tax Attorneys can assist you with establishing an accountable reimbursement plan that satisfies the IRS standard. We have experienced Tax Lawyers ready to assist individuals and businesses in Sacramento, Roseville, Folsom, and the greater Sacramento area.
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