Payroll in Practice: 3.4.2024

Question: A company plans to provide employees with a cash advance to purchase safety shoes. How can this be arranged so that employees do not have to use their own funds to purchase the shoes or have the advance included in income?

Answer: Under an accountable plan, allowances or reimbursements paid to employees for job-related expenses, such as cash advances for the purchase of safety shoes, are generally excluded from an employee’s wages as a working condition fringe benefit and are thus not subject to withholding. This exclusion may also apply to other employer-provided services and facilities that aid employees in their jobs.

For the exclusion to apply, employees must meet any substantiation requirements under an accountable expense reimbursement plan. Under an accountable plan, reimbursed expenditures must qualify as ordinary and necessary employee business expenses. The expenses must have a connection to the employer’s business, must be incurred by an employee in service to the employer, and must be of the sort that would qualify as deductible expenses if paid by the employer directly.

An employer’s allowance or reimbursement policy is considered an accountable plan if there is a business connection to the expenditure, there is adequate accounting of the expenditure, and excess reimbursements or advances are returned within a reasonable period of time.

If a reimbursement arrangement does not meet all three accountable plan rules, the payments are additional wages subject to withholding. This includes any payment or portion of a payment that does not qualify as an expense reimbursed under an accountable plan.

To substantiate an expense, the employee must provide the employer with information that enables the employer to identify the specific nature of each expense. This information typically includes the amount, place of purchase, time or date, and business purpose of the expense. In this instance, a dated original receipt for required safety shoes provides sufficient substantiation. The receipt must remain in company records to document the employer’s expense and the qualification for exclusion of the cost from employee wages.

Employers may also choose to provide cash advances to cover anticipated business expenses. The Internal Revenue Service provides safe harbors related to the timing of provision of advance funds, return of advance funds that exceed expenses, and substantiation of the expenses incurred.

Under the safe harbors, advances should not be issued more than 30 days before the expected incurrence of the expense, and the amount of the advance should be consistent with the expected amount of the expense. Expense substantiation should be provided within 60 days of incurrence of the expense, and any excess funds should be returned within 120 days of expenditures.

Under an alternative safe harbor, the employer issues periodic statements to employees that show the amounts of any outstanding advances. The statements must be issued at least quarterly and for any outstanding amounts employees must substantiate expenses or return any amounts that remain unsubstantiated within 120 days of the statement date.

Providing advances exposes a potential loophole through which employees might buy shoes, return them for a refund, then buy a lower-cost shoe or decline to buy shoes at all. The employee could turn in the original receipt as expense substantiation but retain the refunded cash.

One way to address this issue is for the employer to contract with a supplier to supply shoes to employees, possibly through visits to the worksite to fit and sell the shoes. The employer could pay the supplier directly and avoid the control and administrative issues associated with providing advances or reimbursements.

This column does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., or its owners.

Author Information

Patrick Haggerty is the owner of a tax practice in Chapel Hill, North Carolina, and an enrolled agent licensed to practice before the Internal Revenue Service. The author may be contacted at phaggerty@prodigy.net.

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