The EBAN (Employee By Another Name) dilemma regarding reimbursed expenses
In the last 10 years there has been an explosion of workers who were previously conventional W-2 workers earning a salary who now find themselves self-employed by the same or similar type companies. Often these self-employed people are reimbursed for supplies, travel and meals expenses incurred in servicing their clients.
I’m sure everyone reading this has read articles about the plague of fraudulent tax returns filed in recent years. The IRS has identified form 1099-MISC compliance as a top priority to help combat this fraud; something they really have never focused on years ago.
Quickbooks Online is setup to help small businesses account for and bill clients for expenses incurred in servicing clients. These are commonly known as “Billable Expenses”.
If you are unfamiliar with IRS regulations on reimbursement plans, please read on. Otherwise, you can skip to “How to Account for Pass-through Expenses in Quickbooks Online” below.
The IRS provides for 2 types of reimbursements:
You “account” for your expenses by reporting them to your client and charging the expenses through without adding any fees. Although you are not required to submit receipts, your client is required to have them. So, they will usually ask for them.
From IRS Publication 463: To be an accountable plan, your employer’s reimbursement or allowance arrangement must include all of the following rules:
- Your expenses must have a business connection — that is, you must have paid or incurred deductible expenses while performing services as an employee of your employer.
- You must adequately account to your employer for these expenses within a reasonable period of time.
- You must return any excess reimbursement or allowance within a reasonable period of time.
Usually means you bill the client for expenses, but do not provide detail. You may even mark up your expenses or summarize them on one line. A good guideline is to refer back to the rules for Accountable Plan and determine if your situation does not apply.
Simply stated, under an accountable plan, your income is the amount of your products or services outside of the accountable reimbursement plan. The client should not include your Billed Expenses as part of your compensation on form 1099-MISC.
Under a non-accountable plan, your Income is all your billings you have collected (cash basis); both services and reimbursed expenses.
NOTE: I once found myself in a spirited discussion with my client’s large customer. I found it helpful to help that Accounting Manager understand that Accountable versus Non-accountable is not a subject which can be negotiated by disregarding the underlying tax law. That is, if a contractor is required to, and does, abide by the 3 requirements above, those expenses are deemed Accountable.
Your 1099-MISC should reflect the correct treatment of pass-through expenses. Your Quickbooks should reflect that too.
How to Account for Pass-through Expenses in Quickbooks Online:
- Click on the Gear Icon
- In the left column click “Settings”
- In the next screen on the left, click “Expenses”
- Click in the area “Bills and expenses”
- Select the following:
- Track expenses and items by customer = On
- Make expenses and items billable = On
Here’s where the Accountable versus Non-accountable differ:
- Accountable: Track billable expenses as income = UN-Check Box
- Non-accountable: Track billable expenses as income = Check Box
In Accountable Plans, “Track billable expenses as income” being unchecked will post pass-through expenses as offsets to your expenses on your ledgers, reducing your expenses. This shifts the 50% deductibility from you to your client, which is the correct tax treatment.
In Non-accountable Plans, “Track billable expenses as income” being checked will post pass-through expenses on your client invoices as Revenue, with no effect on your expenses. This maintains the 50% deductibility with you, which is the correct tax treatment (sorry ‘bout that).
What if you have both Accountable and Non-Accountable arrangements with clients?
Quickbooks does not provide for reimbursement plans by client. You need to manage it.
Recommended Method 1:
Maintain the setting above for an accountable plan. At year-end (or an interval you choose), export your expenses to Excel. Identify the ones that are for Non-accountable clients. Make one year-end entry debiting back the expenses and crediting Revenue.
The advantage is that this method is easier throughout the year and you can certainly ask your accountant for help. Your bottom line will be correct. However, your Revenue and Expense will both be deflated by the amount of your pass-through expenses until you make the adjustment in the preceding paragraph.
Recommended Method 2:
Go to Settings each time you enter a bill that will be billed through to a client invoice and follow change the settings for each bill that will be charged to a client and change the settings according to the “Accountable” and “Non-accountable” instructions above.
Naturally, this method is only practical if you have only an occasional pass-through expense that deviates from the majority of your arrangements. The advantage is that your books will be correct throughout the year.
Why bother with this if the bottom line is correct?
Very fair question. There are 2 critical reasons:
- You will not have to respond to an IRS notice in case you under report revenue if you are billing through a Non-accountable Plan. These notices are time consuming in replying and most people agree that your best option is to refile with the correct numbers.
- You will not subject your Meals & Entertainment to the 50% limitation if you are in an “Accountable Plan” arrangement with a client.
Bonus Reason: You will be able to identify and correct any clients who had you set up incorrectly for your 1099-MISC income.