Nonaccountable Plan: Taxation, W-2 Reporting, and Fixes

A nonaccountable plan is an employer arrangement for paying or reimbursing employee business expenses that fails at least one of the three federal requirements for tax-free treatment. When that happens, the money is not a reimbursement in the eyes of the IRS. It is wages. The employer must withhold income tax and payroll taxes, pay its share of FICA and FUTA, and report the amounts on Form W-2 alongside salary. Monthly car stipends, flat travel allowances, and per diems above federal rates are the payments that most often land here.¹

The Three-Part Test

An expense reimbursement arrangement is accountable only if it meets all three of the following. Miss one, and the entire payment is nonaccountable.¹

Business connection. The expense must come from work the employee actually performs and must be ordinary and necessary in the employer’s trade or business. A flat stipend paid whether or not the employee spends anything fails on this point alone.
Substantiation. The employee must document the amount, date, place, and business purpose of each expense. The IRS safe harbor treats submission within 60 days of the expense as timely.²
Return of excess. Any advance or allowance beyond what the employee actually spent has to be returned to the employer. The safe harbor allows up to 120 days after the expense is incurred.

One detail matters more than the rules themselves: an employee cannot rescue a nonaccountable plan by behaving well. If the employer’s arrangement does not require substantiation or return of excess, an employee who keeps receipts and hands back unspent cash still receives taxable wages. The three requirements have to live in the plan’s terms, adopted by the employer, and enforced in practice.

Per Diems Above the Federal Rate

The most common way a well-intentioned employer creates nonaccountable income is by paying travel per diems above the federal rate for the destination. Everything up to the federal rate can ride under an accountable plan. The excess is automatically nonaccountable, taxable as wages, even when the rest of the arrangement is airtight.³

If the federal per diem for a city is $250 and the employer pays $350, the extra $100 per travel day is supplemental wages. Splitting the payment correctly between the accountable portion and the nonaccountable excess is the employer’s responsibility on every trip.

How the Payments Are Taxed

Once a payment is nonaccountable, it is supplemental wages, and every layer of employment tax applies.

Federal Income Tax Withholding

The flat withholding rate for supplemental wages is 22% up to $1 million paid to an employee in a calendar year and 37% on any amount above that threshold.⁴

Social Security and Medicare

The employer and the employee each owe Social Security tax at 6.2% on wages up to the annual wage base, which is $184,500 for 2026.⁵ Medicare tax is 1.45% on each side with no wage cap.⁴ Once an employee’s total wages for the year cross $200,000, the employer must also withhold the 0.9% Additional Medicare Tax on the excess. There is no employer match on that additional 0.9%.⁶

Federal Unemployment Tax

The gross FUTA rate is 6.0% on the first $7,000 of each employee’s annual wages. Employers who pay state unemployment taxes on time get a credit of up to 5.4%, taking the effective rate to 0.6% in most cases. Employers in states with outstanding federal unemployment loans may see the credit reduced.⁷ State unemployment wage bases run from $7,000 to over $78,000, so the total unemployment cost of nonaccountable payments depends heavily on where the employee works.

Withholding attaches when the money is paid or when the substantiation window closes without proper documentation, whichever comes first. Missed deposits carry escalating penalties under Section 6656.⁸

How Nonaccountable Payments Are Reported

Form W-2

Nonaccountable amounts are folded into the employee’s gross wages on Form W-2. They show up in Box 1 (wages), Box 3 (Social Security wages, up to the wage base), and Box 5 (Medicare wages).¹ There is no separate box or code that identifies them as former reimbursements. They read like any other compensation.

Form 941

Federal income tax and FICA withheld from nonaccountable payments are reported on the quarterly Form 941 along with all other wages.⁹ The IRS reconciles the four quarterly 941 filings against the annual Form W-3 totals. Discrepancies are a common trigger for payroll notices, so an employer that starts treating a stipend as taxable mid-year needs the change to flow through both filings consistently.

Form 940

Nonaccountable payments are wages for FUTA and belong on Line 3 of Form 940, which captures total payments to all employees for the year. FUTA applies only to the first $7,000 paid to each employee.¹⁰ For employees already well above that threshold in regular wages, the FUTA impact of a nonaccountable payment is often zero. For seasonal or lower-wage workers, it can matter.

The Employee’s Side: No Deduction Available

The tax hits an employee harder than salary because the money often covers real out-of-pocket business costs. Before 2018, an employee could claim unreimbursed business expenses as a miscellaneous itemized deduction subject to a 2% floor. That door is closed. The 2017 tax reform suspended all miscellaneous itemized deductions, and later legislation removed the 2025 sunset, making the suspension permanent under Section 67(h).¹¹

The result is a hidden pay cut. An employee who receives a $500 monthly car allowance under a nonaccountable arrangement and spends every dollar of it on business gas and maintenance still pays income tax and FICA on the full $6,000 for the year, with nothing to claim on the personal return. Depending on the bracket, roughly 30% or more of the allowance leaves in federal taxes alone.

The Narrow Exceptions

Four groups of employees still deduct unreimbursed work expenses on Form 2106:¹²

Armed Forces reservists, including National Guard and the Reserve Corps of the Public Health Service, for expenses tied to reserve duties.
Qualified performing artists who worked for at least two employers during the year, earned at least $200 from each, had performing arts expenses over 10% of related income, and had adjusted gross income of $16,000 or less before the deduction.
Fee-basis state or local government officials compensated in whole or in part by fees rather than salary.
Employees with impairment-related work expenses, meaning workers with physical or mental disabilities who pay for attendant care or workplace accommodations that let them do the job.

Trust Fund Exposure for Owners and Officers

Income tax and the employee share of FICA withheld from any wages, including nonaccountable payments, are trust fund taxes. The employer holds the money for the Treasury. If the business fails to deposit those withheld amounts, the IRS can go past the entity and assess the Trust Fund Recovery Penalty against individual owners, officers, or anyone with authority over company finances who directed the money elsewhere.¹³

The penalty is 100% of the unpaid trust fund taxes. Willfulness does not require an intent to break the law; paying other creditors while knowing employment taxes are outstanding is enough. Collection can reach the responsible person’s personal assets, including through liens and levies. This is where nonaccountable plan mistakes turn dangerous. An employer that pays a monthly stipend for years, never withholds because it treated the payment as a tax-free reimbursement, and later gets reclassified faces a trust fund liability that follows the people who ran payroll home.

Contractors Are Treated Differently

The rules above are about employees. When a business reimburses an independent contractor under a nonaccountable arrangement, the payment goes on Form 1099-NEC, Box 1, if the year’s total reaches $600.¹⁴ The business does not withhold income tax or FICA. The contractor handles income tax and self-employment tax on the amount. Missing the 1099-NEC still carries penalties and can cost the deduction.

Fixing a Nonaccountable Plan

Converting to an accountable arrangement is not complicated on paper. The employer adopts a written policy that requires a business connection for every expense, substantiation within 60 days, and return of any excess within 120 days.¹

The harder part is enforcement. A policy that sits in a handbook while payroll keeps cutting flat monthly checks still operates as a nonaccountable plan. Employers who make the switch should build substantiation and excess-return into the expense system so compliance happens by default rather than depending on anyone remembering to chase receipts.

1
eCFR. 26 CFR 1.62-2 – Reimbursements and Other Expense Allowance Arrangements
2
Internal Revenue Service. Revenue Ruling 2003-106
3
Internal Revenue Service. Per Diem Payments Frequently Asked Questions
4
Internal Revenue Service. Publication 15 (2026), (Circular E), Employer’s Tax Guide
5
Social Security Administration. Contribution and Benefit Base
6
Internal Revenue Service. Topic No. 560, Additional Medicare Tax
7
Internal Revenue Service. Topic No. 759, Form 940 – Employer’s Annual Federal Unemployment (FUTA) Tax Return
8
Office of the Law Revision Counsel. 26 USC 6656 – Failure to Make Deposit of Taxes
9
Internal Revenue Service. Instructions for Form 941
10
Internal Revenue Service. Instructions for Form 940
11
Office of the Law Revision Counsel. 26 USC 67 – 2-Percent Floor on Miscellaneous Itemized Deductions
12
Internal Revenue Service. Instructions for Form 2106
13
Internal Revenue Service. Employment Taxes and the Trust Fund Recovery Penalty (TFRP)
14
Internal Revenue Service. Instructions for Forms 1099-MISC and 1099-NEC