12 Ways to Reduce the Increased Threat of Expense Report Fraud under Tax Reform by Richard A. Pollack, CPA
Entertaining clients, referral sources and employees with tickets to sporting events, country club outings, fishing trips or other forms of business promotion are common business practices. No matter how significant these costs, businesses have had the reassurance that the IRS would permit them to deduct all or a portion of these meals and entertainment (M&E) expenses from their taxable income. This benefit changes in 2018 with the passage of the Tax Cuts and Jobs Act (TCJA), which limits or, in some instances, eliminates the deductibility of M&E expenses and potentially puts businesses at greater risk of falling victim to expense report fraud.
While taxpayers are accustomed to keeping track of the costs they incur for activities that are “ordinary, necessary and directly related to the active conduct of a trade or business or for the production or collection of income,” the language of the new tax law complicates the rules regarding the deductibility of these expenses beginning in 2018. Gone are deductions for entertainment expenses, while certain meals enjoyed outside of entertainment activities may be 50 percent deductible when they meet certain criteria. As a result, businesses and workers that frequently entertain clients or referral sources will likely feel the loss of the tax savings that they once enjoyed. This, in turn, may create an environment in which employees seek out ways to get around the new rules and manipulate their expense reporting.
What is Expense Reimbursement Fraud?
According to the Association of Certified Fraud Examiners’ 2018 Report to the Nations, expense reimbursement fraud is one of the most common types of occupation fraud. While it can be easy to identify, once detected, it often indicates just the tip of the iceberg in a larger scheme that can cost businesses millions of dollars. Therefore, it is critical that businesses understand the following forms of expense report fraud that employees commonly commit, and be vigilant in recognizing early warning signs:
- Mischaracterizing expenses by falsely claiming purchases for personal use are business expenses;
- Creating fictitious expenses by producing bogus receipts for expenses that they never incurred;
- Padding expense reports by overstating or inflating legitimate expenses;
- Remitting the same receipt more than once in an effort to yield multiple reimbursements for one expense.
Importantly, businesses must recognize that even a minor embellishment, such as rounding up the costs of a business lunch, can quickly turn into a more elaborate scheme that can go unnoticed for years. To avoid falling victim to fraudulent schemes and exposing themselves to millions in losses, businesses should have in place appropriate controls to prevent deceptive business practices and/or to monitor and detect misuse and abuse.
Preventing Expenses Report Fraud
While the TCJA represents some of the most significant changes to the U.S. Tax Code, its rapid enactment into law leaves taxpayers with numerous uncertainties in how they should interpret many of its provisions. However, there are certain steps that businesses can and should take to reduce their exposure to fraud and the economic and reputational losses that they will incur because of these schemes.
- Establish and educate employees about changes to written corporate expense policies, for which non-deductible entertainment expenses should be separate from potentially deductible meal expenses;
- Assess membership and other fees associated with professional trade organizations (deductible), entertainment venues (nondeductible) and event sponsorships (for which the fair market value of the sponsorship may be deductible);
- Require employees to submit original receipts that describe the expense, the names of the attendees/participants, the business purpose of meetings/meals, and the topics of business discussed;
- Require employees to attach to receipts additional proof that an expense is work-related (i.e. conference brochure) and not a form of entertainment;
- Establish a policy that requires supervisors/managers, payroll or HR personnel to review/approve every one of workers’ expense reports prior to reimbursements;
- Compare workers’ expenses to their work schedules, prior month and prior year expenses;
- Avoid reimbursing workers in cash;
- Consider using the IRS-recommended per diem rates for meals and mileage;
- Consider the use of corporate credit cards to track employee’s expense activities and compare them to expense reports;
- Verify mileage claims and require employees to detail claims of miles traveled by including exact addresses of locations;
- Conduct spot audits to detect anomalies or flag unverified expenses; and
- Strictly enforce expense-reporting policies, investigate suspicious claims and establish a formal system for managing the process and prosecuting fraudsters.
Businesses should not overlook the potential impact expense reimbursement fraud can have on their operations, their corporate reputation and their net income.
About the Author: Richard A. Pollack, CPA/ABV/CFF/PFS, ASA, CBA, CFE, CAMS, CIRA, CVA, is director-in-charge of the Forensic and Litigation Support practice with Berkowitz Pollack Brant, where he has served as a litigation consultant, expert witness, court-appointed expert, forensic accountant and forensic investigator on a number of high-profile cases. He can be reached at the CPA firm’s Miami office at (305) 379-7000 or via email at firstname.lastname@example.org.