Deducting employee car expenses can present substantial savings, but watch out if you do not have proper book-keeping measures in order. Recouping some of these expenses are an excellent employer benefit, and one of the key ways the IRS allows us to gain a tax benefit from every day employment functions. Whether you’re self-employed, or a W-2 employee, it’s important to evaluate the distinctions, how to file and what kind of book-keeping records are expected from the IRS.
Let’s consider how it works for W-2 employees. Many of us do not scrutinize our paycheck to extract the tax implications - or, at least we don’t necessarily need to do so until tax time arrives. So, what exactly should you be looking for? Perhaps you have heard of an accountable plan or a nonaccountable plan with your employer. Or, maybe your employer didn’t use these words, in particular, when describing car expense reimbursement, but this is how they handle these benefits in their book-keeping systems. If your employer has you on an accountable plan, the car expense reimbursements generally are not included in your wages on the W-2 form and therefore deducting the expenses would be incorrect. To be an accountable plan, there are some rules that the employer’s reimbursement plan must follow. For example, there must be a relevant business purpose for your expenses, in that, as you’re paying these deductible expenses you were actually performing activities in the capacity of an employee for your particular employer. There are also accounting requirements where you must provide details of these expenses within an appropriate amount of time to the employer. Also, if you are reimbursed in overage, you must return these amounts within an appropriate amount of time as well. If you meet these accountable plan rules, you must also evaluate if your expenses equal your reimbursements in which case you would not complete form 2106. In some cases, you may need to ask for a correction on your W-2. It’s also important to remember how critical the book-keeping is for accountable plans. Typically, you should be providing a statement of expense or some other platform where you communicate each expense around the time you incurred the expense as well as documentation, such as receipts and mileage records. A car allowance or per diem allocation can fulfill what is needed in some cases. Basically, even if you are not self-employed, the onus is on you to justify reimbursements with proper book-keeping and supporting documentation in the event the IRS ever questioned your return. If it’s not accounted for, you’re expected to pay it back, in other words. A side-note to consider is that when the rules of accountable plans aren’t fully met, sometimes the IRS treats the plan as a nonaccountable plan even though it’s labeled an accountable plan.
With nonaccountable plans, the accountable plan rules mentioned above don’t apply and the car expense reimbursements generally are included in your W-2 wages. This information is typically reflected in the total with your wages, salary or other compensation. In this case, car expense reimbursements often can be handled as an itemized deduction. To clarify, the nonaccountable plans reimburses you for business expenses by reflecting a lower amount reported for your salary. The employer should be reporting the total in your W-2, box 1, and you may itemize the deductions for employee car expenses, if desired. Realizing this can be confusing, anyone who is unsure of their employer’s structure for employee car expenses should inquire with the employer and not assume one plan or the other based on the W-2, alone, in the event the employer has indicated the information incorrectly, and a corrected W-2 may be needed.
Also, remember the importance of book-keeping and recordkeeping. Great book-keeping will ensure you are able to confidently answer questions if the IRS ever asks. This, combined with maintaining correct recordkeeping timeframes will help keep you stay out of trouble. For example, if you owed taxes/didn’t receive a refund after filing taxes, you should keep receipts and records for three years from return filing. However, if fraud comes into play, then there is no period and rules vary if any income went unreported, in which case six years of record retention comes into play.
The bottom line is, rules vary and relying on your employer isn’t going to cut it if the IRS comes knocking. Make sure you understand your employee car expense reimbursement plan, and that your book-keeping can satisfy the auditors needs and fully justify your deductions.
