Small business owners often pay business expenses personally—fuel, travel, office supplies, or equipment—and later reimburse themselves from the business. But whether those reimbursements are tax-free or taxable income depends on whether the business follows the IRS rules for an accountable plan.

When properly structured, an accountable plan allows employees—including owner-employees of S corporations—to receive reimbursements without those payments becoming taxable income.

Understanding these rules can save businesses significant tax dollars.

The Legal Framework: IRC § 62 and Treasury Regulations

The authority for accountable plans comes from Internal Revenue Code § 62(a)(2)(A) and Treasury Regulation § 1.62-2, which establish the conditions under which expense reimbursements are excluded from income.

Treasury Regulation 26 C.F.R. § 1.62-2(c) states:

“Amounts paid under an accountable plan are excluded from the employee’s gross income, are not reported as wages… and are exempt from the withholding and payment of employment taxes.”

However, reimbursements must satisfy three core requirements to qualify.

The Three Requirements of an Accountable Plan

Under 26 C.F.R. § 1.62-2(d)–(f), a reimbursement arrangement qualifies as an accountable plan only if it meets the following criteria.

1. Business Connection Requirement

The expenses must have a legitimate business purpose.

The regulation provides:

“An arrangement meets the business connection requirement if it provides advances, allowances, or reimbursements only for business expenses that are allowable as deductions.”
— 26 C.F.R. § 1.62-2(d)

Examples of qualifying expenses include:

• Travel for business
• Client meals
• Professional dues
• Office supplies
• Equipment purchases
• Mileage driven for business purposes

Personal expenses do not qualify.

2. Substantiation Requirement

Employees must properly document the expenses.

Treasury Regulation 26 C.F.R. § 1.62-2(e) states:

“An arrangement meets the substantiation requirement if the employee substantiates each business expense to the payor within a reasonable period.”

Typical substantiation includes:

• Receipts
• Mileage logs
• Dates and locations of travel
• Business purpose of the expense

This requirement is closely related to the substantiation rules of IRC § 274(d) for travel, meals, and listed property.

3. Return of Excess Requirement

If the employer provides an advance that exceeds actual expenses, the excess must be returned.

The regulation explains:

“An arrangement meets the return of excess requirement if the employee returns amounts in excess of substantiated expenses within a reasonable period.”
— 26 C.F.R. § 1.62-2(f)

Failing to return excess reimbursements can convert the entire payment into taxable wages.

What Happens If These Requirements Are Not Met?

If any of the accountable plan rules are violated, the reimbursement becomes taxable compensation.

Treasury Regulation 26 C.F.R. § 1.62-2(c)(3) provides:

“Amounts paid under a nonaccountable plan are included in the employee’s gross income and are subject to withholding and employment taxes.”

This means the payments must be reported on Form W-2 and are subject to:

• Income tax
• Social Security tax
• Medicare tax

Why Accountable Plans Matter for Small Businesses

The accountable plan rules are especially important for:

• S corporation shareholders
• Small business owners
• Independent contractors transitioning to employee status

Without an accountable plan, many expenses become nondeductible or inefficiently taxed.

For example:

Scenario 1: No Accountable Plan

Owner reimburses themselves $10,000 in expenses.

Result:

• $10,000 added to wages
• Payroll taxes apply

Scenario 2: Accountable Plan

Owner substantiates $10,000 in expenses.

Result:

• $10,000 reimbursed tax-free
• No payroll taxes
• Business still receives deduction

This difference can save thousands annually.

Common Expenses Reimbursed Under Accountable Plans

Typical reimbursable expenses include:

• Business mileage
• Home office expenses for S-corp shareholders
• Business travel
• Continuing education
• Professional software subscriptions
• Cell phone usage for business

Many accountants recommend that S corporations use accountable plans specifically to reimburse home office expenses, which cannot be deducted directly on the shareholder’s individual return.

How to Set Up an Accountable Plan

The IRS does not require a complex document, but best practices include:

1. Written accountable plan policy
2. Defined reimbursement procedures
3. Expense report forms
4. Receipt and documentation requirements
5. Deadlines for substantiation and return of excess funds

Many businesses implement these procedures through internal accounting software or standardized reimbursement forms.

Final Thoughts

Accountable plans are one of the most overlooked tax tools available to small businesses. When properly implemented, they allow companies to reimburse legitimate business expenses without increasing taxable income or payroll taxes.

For business owners and employees alike, understanding the accountable plan rules under IRC § 62 and Treasury Regulation § 1.62-2 can significantly improve tax efficiency and ensure compliance with IRS reporting requirements.

At Dino Tax Co, we help clients navigate tax matters ranging from unfiled returns to IRS letters and levies and everything in between with clarity and confidence. If you’d like guidance on your situation, schedule a consultation today. Call or text (713) 397-4678 or email davie@dinotaxco.com. We’re here to help you take the next step.