Reduce Employer and Employee Taxes With a Salary Reduction Plan

Many employees are reimbursed by their employers for business expenses. The employer gets a tax deduction for the reimbursement and the employee is exempt from taxation on the reimbursement. In cases where employers do not reimburse employees for business expenses, the employees' only option is to deduct those expenses as a miscellaneous itemized deduction subject to the 2%-of-AGI limit. Very often this 2% threshold translates into $0 tax benefit for the employee.

But there is a better way to do this that can save both the employer and employee income tax and employment taxes. What's the great idea?

Set up a salary reduction plan. Under such a plan the employer arranges to set aside a mandatory portion of the employees' salaries. This money is then used to reimburse the employees for any employee incurred business expenses. It's a win-win for the employer and the employee. For the employer, they recognize a reduction in employment tax (employer Social Security and Medicare tax) on the deferred salary and receive a tax deduction for the reimbursement amount. For the employees they recognize a reduction in their federal income tax (and maybe their state income tax) as well as a reduction in their employment taxes (Social Security and Medicare tax). Better still, employees don't have to report the reimbursements as taxable income and are not hampered by the 2% threshold test in realizing a tax benefit.

In order to qualify for the beneficial tax treatment on this arrangement the employer must establish a formal salary reduction plan with mandatory participation of all employees. The employer must then track the amount of each salary reduction, account for employee business expense claims and make reimbursements.

Tom is a Certified Public Accountant, a Certified Financial Planner, CLTC (Certified Long-Term Care) and President of Cerefice & Company, the largest CPA firm in Rahway, New Jersey. Tom works with clients helping them manage their money, retirement planning, college savings, life insurance needs, IRAs and qualified plan rollovers with an eye towards maximizing tax benefits and minimizing taxes. Tom is founder of the Rich Habits Institute and author of "Rich Habits".