Question

Bob owns a business and Roy is his key employee but does not have an equity interest in the business. However, Roy is more valuable to the business and actually gets paid more than Bob. Both of them incur expenses for publications, attending seminars, etc. Do they both treat their expenses the same for federal income tax purposes? If they are different, who gets the better treatment?

Answer 1

Ques; Do they both treat their expenses the same for federal income tax purposes? If they are different, who gets the better treatment?

Ans. The expenses incurred by Bob and Roy are not treated same under the federal income tax purposes. Also, Bob will get the better treatment under federal income tax.

Explanation: The expenses for publications, attending seminars, etc are considered as “Business Expenses” which are deductible from business taxable income. Because these expenses are not used to “figure cost of goods sold, Capital expenses and Personal expenses”. IRS Publication 535, Business Expenses, states the following: “To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your industry. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary.”

In this case, “Bob” is the owner of the business, so the income of the business generally must be reported by the “Bob” on the owner’s individual income tax return as self-employment income from a sole proprietorship. “Roy” is the employee of this business, so the income of “Roy” generally must be reported as his “Wages and Other Compensation”.

So Bob can deduct the full amount of a business expense for publications, attending seminars, etc, from his “self-employment income from a sole proprietorship”. Also, “Bob” requires to reimburse Roy’s business expense for publications, attending seminars, etc, since the expenses incurred by employees in the course of business should be costs incurred by the employer, not by its employees. In such case, Bob can deduct the amount of reimbursement. When the amount of reimbursement received, Roy won’t be required to report such payments as his “Wages and Other Compensation”.

The deduction of reimbursement depends on whether you reimburse the expenses under an accountable plan or a nonaccountable plan. In order to have an accountable plan, an expense reimbursement plan or advance payment program must meet the following three conditions:

1. They must have paid or incurred deductible expenses while performing services as your employees. The reimbursement or advance must be payment for the expenses and must not be an amount that would have otherwise been paid to the employee as wages.

2. They must substantiate these expenses to you within a reasonable period of time.

3. They must return any amounts in excess of substantiated expenses within a reasonable period of time.

In order to reimburse employees for expenses, it’s important for an employer to have an accountable plan.

If an employer does not have an accountable plan in place, then IRS Publication 15 states: “Payments to your employee for travel and other necessary expenses of your business under a nonaccountable plan are wages and are treated as supplemental wages and subject to the withholding and payment of income, social security, Medicare, and FUTA taxes.”

So, even if the expenses are ordinary and necessary, if the Bob does not have an accountable plan, then any reimbursements are treated as supplemental wages which are taxable income under Roy’s “Wages and Other Compensation”.

Conclusion:

If Bob have Accountable plan

After considering the above facts, Bob can deduct his portion of business expense for publications, attending seminars, etc., and also deduct the reimbursement towards Roy.

If Bob doesn’t have Accountable plan

Bob can deduct his portion of business expense for publications, attending seminars, etc., and also deduct the reimbursement towards Roy. The reimbursements are treated as supplemental wages which are taxable income under Roy’s “Wages and Other Compensation”.