Underreporting Compensation via Overreporting Business Expenses = Tax Fraud
If you run a business, chances are your employees will incur job-related expenses. Some employers offer reimbursement to their employees for these expenses. If reimbursed, the Internal Revenue Code says for tax purposes, neither the expense nor the reimbursement is claimed on the employee’s tax return. Further, the reimbursement is not reported as income on the employee’s Form W-2.
Thing is, the business expenses need be legitimate and substantiated by adequate records. While that makes perfect sense, it doesn’t mean everyone follows the rules.
Mr. Rasey of Powell, Ohio was the owner of Macloud Financial, Inc., a mortgage-brokerage firm. Mr. Rasey set up an “employee reimbursement account” for his employees. They were encouraged by Mr. Rasey to claim up to 80 percent of their compensation as reimbursement for business expenses, effectively subjecting only 20 percent of their compensation to withholding, and re-characterizing the reimbursement amounts as expenses for the firm. When employees questioned their boss about this arrangement, he told them he had an expert verify its legality.
The flags: Excessively high company business expenses, and excessively low compensation. So the IRS investigated.
The expenses were obviously illegitimate, resulting in the underpayment of employment taxes of $341,849 for the tax years 2002, 2003, and 2004. Mr. Rasey pleaded guilty to conspiring to defraud the IRS, and will serve 21 months of time.
If your employer encourages you, the employee, to claim for reimbursement of business expenses that you know don’t exist, find another job yesterday.