A letter of intent to buy a business is a short document that records the main terms of a proposed deal before you spend serious time and money on diligence and a purchase agreement. In a typical private deal, the commercial terms, including price, deal structure and any earnout, stay non-binding until a definitive agreement is signed. A smaller set of process terms, most often confidentiality and exclusivity (a no-shop), are written to be binding so both sides can work through diligence without the seller shopping the deal in the background.

You’ll also hear it called an LOI, a memorandum of understanding, a term sheet or an indication of interest. The title on the page matters less than the language inside it. If the document is sloppy about what’s binding, you can end up locked into a deal you thought you could still walk away from, or you can spend weeks on diligence while the seller keeps talking to someone else. This is education, not legal advice. Have an M&A attorney read it before you sign, especially before you agree to exclusivity.

What a letter of intent is for (and what it is not)

The LOI sits in the middle of a purchase, after you’ve decided the business is worth a closer look and before anyone is legally committed to close. It is not the purchase agreement. It should not try to settle every diligence issue, and it should not replace a valuation or a structure decision. If you still need to work out what the company is worth, do that work first with a clear method for how to value a small business. If you still need to decide whether you’re buying assets or stock, that’s a separate call, covered in asset sale vs stock sale, and it should stay open in the LOI until diligence supports it.

Used well, the letter does three jobs. It puts the big business terms on paper so both sides are talking about the same deal. It sets the ground rules for the next stretch of work, including confidentiality and how long the seller will deal only with you. And it gives everyone a chance to spot a deal-breaker early, before legal bills pile up.

What usually belongs in the letter

There’s no official form, and you should not sign a generic template as if it were legal advice. That said, a useful letter of intent to buy a business usually covers:

• The parties and a clear description of what’s being bought
• A proposed price or pricing formula, and how it would be paid
• A proposed structure (asset sale, stock sale or a mix), labeled as non-binding
• Any earnout, seller financing or holdback, also labeled as non-binding until the definitive documents
• A diligence plan and a target timing for a definitive agreement
• Confidentiality, or a pointer to a signed NDA
• Exclusivity or a no-shop, with a start date, an end date and a clear description of what’s not allowed
• Who pays whose expenses if the deal dies
• Governing law, and a clear statement of which sections are binding and which are not
• A statement that neither side is obligated to close until a definitive agreement is signed

If a term is important enough to fight about later, it should appear in the letter in plain language. If it’s still a guess, label it as a proposal, not a promise.

What should stay non-binding

Price, payment terms, deal structure, closing conditions, employment and transition details, non-competes and earnouts are the terms counsel usually want to keep non-binding in the LOI. You’re recording a shared direction, not making a sale. Diligence can change the number, the structure or whether you want the deal at all.

The letter should say that, clearly. A heading that calls the document “non-binding” is not enough if the commercial clauses sound like a contract and both sides start acting as if the deal is done. Courts can look at the words and at the conduct. Don’t take over the shop, start paying the seller’s bills, or announce a closed deal while the letter still says you can walk.

Leave yourself a clean off-ramp: no obligation to negotiate to a close, and no obligation to sign a purchase agreement, unless your attorney has a specific reason to write something narrower. Sellers want that too. If this buyer falls through, they need to be free to talk to the next one once the binding process terms expire.

What should usually be binding

Two process terms are the ones buyers and sellers most often make enforceable even when the rest of the letter is not.

Confidentiality. You’re about to see financials, customer lists, contracts and problems the public doesn’t see. The LOI should either restate confidentiality or point to an NDA that’s already signed. That obligation should survive if the deal dies. The buyer should only use the information to evaluate this transaction, and should return or destroy it if you walk away, on terms counsel is comfortable with.

Exclusivity, or a no-shop. This is often the reason a buyer wants a letter at all. Once you hire a lawyer and a CPA, you don’t want the seller using your offer to run a parallel auction. A binding no-shop should say, in so many words, that it is binding even though the rest of the letter is not. It should have a finite end date. It should spell out what the seller (and their brokers and advisors) may not do: solicit other buyers, share information with them, or negotiate a competing deal, for that period.

How long that period should last is a business call, not a universal rule. In private deals, counsel often describe windows measured in weeks, commonly in a 30- to 90-day range, long enough to finish diligence and short enough that a seller is not off the market forever. A period that’s too short can leave you exposed just as the work gets expensive. A period that’s too long can be a hard ask for a seller who still has other interest. Put the date in the letter and watch it. When it expires, the seller is generally free to talk to someone else unless you extend it in writing.

Expense allocation and governing law are also often written as binding, so there’s no fight later about who pays for a failed process or where a dispute would be heard. If those clauses appear, say they’re binding.

The exclusivity trade, from both sides

If you’re the buyer, exclusivity is the main thing you’re paying for with the letter. You’re about to spend real money to test the story behind the asking price. Get the scope right. A no-shop that only says “won’t solicit” may still allow the seller to entertain an unsolicited offer, depending on the wording. If that matters to you, say so and have counsel draft it.

If you’re the seller, you’re taking your business off the market for a stretch of time. Don’t give that away casually. Confirm the proposed price and structure are close enough to justify a pause. Limit the period. Be careful about deposit or breakup-fee language you don’t understand. And don’t let a “letter of intent” quietly become a commitment to sell because the non-binding language is weak.

Public-company deals can involve fiduciary duties that change how tight a no-shop can be. Most small-business sales are private, but the point is the same: don’t copy a clause from a template and assume it fits.

What to do before you sign

Read the letter once for the deal, and a second time for the binding sections. Then do this:

1. Highlight every sentence that creates an obligation now, including confidentiality, exclusivity, expenses and any deposit.
2. Confirm the commercial terms are clearly non-binding, and that nothing in the letter requires you to close or to keep negotiating after you’ve decided the deal is wrong.
3. Check the exclusivity end date and the scope, and make sure it matches the diligence you still have to do.
4. Have an M&A attorney review it before you sign exclusivity. The cost of that review is small next to 60 days off the market, or a fight about whether you already sold the company.

I’m not your lawyer, and this isn’t a form to copy. The letter of intent is a tool for getting the next stage of a deal in writing. Used carefully, it lets you learn what you need to learn and still walk away from the price or the structure. Used carelessly, the parts you thought were just a sketch are the parts that hold.

Frequently asked questions

What is a letter of intent to buy a business?

It’s a preliminary document that records the proposed terms of a purchase before a definitive agreement is signed. In most private deals, price and structure stay non-binding, while confidentiality and exclusivity are often written to be binding.

Is a letter of intent legally binding?

It depends on the language, and sometimes on how the parties behave. Many LOIs are non-binding on the sale itself but binding on specific process terms. The document should say, clearly, which sections are which.

What should be binding in an LOI?

Confidentiality and exclusivity (a no-shop) are the terms most often made binding. Expense allocation and governing law are often binding too. The letter should say so expressly, even if the rest of the document is non-binding.

What should stay non-binding in a letter of intent?

Purchase price, payment terms, deal structure, earnouts, closing conditions and transition details usually stay non-binding until a definitive purchase agreement is signed, so diligence can still change the deal or end it.

How long does exclusivity last in an LOI?

There’s no official period. Private-deal counsel often describe a defined window of about 30 to 90 days, long enough to finish diligence. The letter should state a clear end date. When it expires, the seller can usually talk to other buyers unless you extend it.

Should I sign a letter of intent without a lawyer?

It’s a bad idea once exclusivity is on the table. An M&A attorney can check whether the commercial terms are truly non-binding and whether the no-shop, confidentiality and any deposit terms say what you think they say.

A business emergency fund is cash you keep in a separate account to cover your essential operating costs when revenue drops or a surprise bill lands, so you don’t have to borrow in a panic, max out a card or stop paying yourself. The common guideline from banks is three to six months of essential expenses, but that’s a starting point, not a law.

People search for this a few ways: small business emergency fund, business cash reserve, operating reserve, how much cash should a business keep on hand. Same idea. This is education, not financial advice, so talk to your CPA or a licensed financial professional about your numbers.

Why most small businesses run thinner than they think

Most owners can tell you their revenue. Far fewer can tell you how many days they’d last if it stopped.

The best benchmark I know comes from the JPMorgan Chase Institute. Its Cash is King report looked at 597,000 small businesses using 2015 Chase account data and found the median one held enough cash to cover just 27 days of normal outflows. A quarter held fewer than 13 days. The median restaurant had 16. The data is old, but the lesson isn’t: most businesses are one bad month from a hard decision.

Twenty-seven days. That’s one slow client, one delayed payout or one broken piece of equipment away from trouble.

How much should a business emergency fund be?

Start with essentials, not every expense. If revenue fell off a cliff tomorrow, what would you still have to pay to keep the doors open?

1. Add up your essential monthly costs: rent, payroll for people you’d keep, software you can’t run without, insurance, loan payments and a bare minimum owner’s pay.
2. Leave out things you’d cut immediately, like ad spend, new hires or the conference trip.
3. Multiply that essential number by the months you want covered.
4. Adjust for how risky your business is, using the table below.

Here’s an example. Say your essential costs come to $12,000 a month. Three months is $36,000. Six months is $72,000. Example numbers only, but the math works the same for any business.

Wells Fargo’s small business cash reserve guide uses the same three to six month range and suggests seasonal or downturn-sensitive businesses consider nine or even 12 months. I’d treat those as ranges to think about, not targets to hit by Friday.

Business emergency fund vs runway

These get mixed up. Runway is how long a business that’s losing money can keep going before the cash runs out, which is why founders track burn rate and runway so closely. An emergency fund is different. It’s a reserve a working business holds on top of normal operations so a shock doesn’t turn into a crisis. A profitable business still needs one.

Is a line of credit enough?

A line of credit is a backup. It’s not an emergency fund. The bank decides whether you get it, how much and whether you keep it, and that decision often gets tougher at exactly the moment you need the money.

The Federal Reserve’s 2026 Report on Employer Firms (from the 2025 Small Business Credit Survey, published March 2026) found that 56% of firms that sought financing did it to meet operating expenses. Only 42% of applicants got the full amount they asked for, and 22% got nothing. Of firms with debt, 59% had used a personal guarantee. So the “I’ll just borrow” plan often means borrowing against your own house while you’re under pressure.

Here’s what I’d do. Build the cash first. Open the line of credit while things are good, as a second layer, and don’t count it as part of the fund.

Where to keep a business emergency fund

The job of this money is to be there. Not to grow fast. That means:

• A separate account. If it sits in operating checking, it gets spent. A separate business savings or money market account makes you stop and think.
• Insured or very low risk. The FDIC insures deposits up to $250,000 per depositor, per insured bank, for each ownership category. If your fund is bigger than that, ask your banker or CPA how to stay inside coverage.
• Quick to reach. You should be able to move it within a day or two. Some banks’ guides also mention short-term Treasury bills and CDs, but check access and penalties first.
• Not invested in stocks or crypto. A fund that can fall hard the week you need it isn’t an emergency fund.

How to build one without starving the business

You don’t need six months saved by next quarter. You need a first milestone and a habit.

1. Work out your essential monthly number this week.
2. Set a first target of one month of essentials. Then build toward three.
3. Pick a fixed dollar amount and move it to the reserve every time a client payment lands, or on the same day each week.
4. Send windfalls there first: a big project, a tax refund, a once-off sale.
5. Don’t count money customers owe you. Receivables aren’t cash until they clear.
6. Review the target every quarter as your costs change.

Plenty of people know they should do this and never start. Knowing you need a cushion and actually having one are two very different things. Automate it so you don’t have to rely on willpower.

What counts as a business emergency?

Write this down before you need it, so you’re not making the call at midnight when you’re stressed.

• Yes: a sudden revenue drop, a major client not paying, critical equipment failing, a cyber incident, a natural disaster, covering payroll while a big invoice clears.
• No: a new hire you want, a marketing test, an upgrade that would be nice, a slow month you could have planned for.

If you do use it, rebuild it right away, using the same automatic transfer. If the downturn lasts longer than a bad month, the playbook on how to grow your business in a recession covers the moves that go with the cash.

Do you need a personal emergency fund too?

Yes, especially if you’re solo. Your business fund protects the business. Your personal fund protects your rent and groceries if the business has to stop paying you for a while. Keep them separate. Mixing them is how owners end up draining the business to cover life, or the other way around, and losing track of both.

Frequently Asked Questions

How much should a small business have in an emergency fund?

Many bank guides suggest three to six months of essential operating expenses. Seasonal businesses, or those with heavy fixed costs or slow-paying clients, often aim higher.

Where should I keep my business emergency fund?

In a separate, easy-to-access business savings or money market account at an FDIC-insured bank. Keep it out of stocks and crypto.

Is a business line of credit the same as an emergency fund?

No. A lender can shrink, freeze or deny credit, often when conditions are worst. Use a line of credit as a second layer behind your cash.

What is the difference between an emergency fund and an operating reserve?

They’re mostly the same thing. “Operating reserve” is the term nonprofits and accountants tend to use, while “emergency fund” is the everyday phrase for cash set aside for shocks.

Should I use business profits or personal savings to build it?

Build it from business cash flow so you keep business and personal money separate. Talk to your CPA about how transfers and owner draws should be recorded.

How fast should I rebuild the fund after using it?

Start right away with the same automatic transfer, and send any windfalls there first. The goal is to get back to your first milestone before the next shock.

The startup costs deduction, under Internal Revenue Code section 195, lets a business deduct some of the money it spent investigating or creating an active trade or business in the year that business actually begins. The immediate deduction is the lesser of those startup costs or $5,000, and that $5,000 is reduced dollar-for-dollar once total startup costs go over $50,000, so it reaches zero at $55,000 or more. Whatever is left is deducted ratably over 180 months, starting with the month operations begin.

IRS Publication 583 (December 2024), Starting a Business and Keeping Records, describes startup costs as expenses you incur “before you actually begin business operations,” and lists advertising, travel, surveys and training as typical examples. It also notes that assets such as machinery or office equipment are generally recovered through depreciation, not this deduction. This is education, not tax advice. Talk to a CPA about what you spent, when the business began, and how to report it.

What counts as a startup cost, and what doesn’t

Section 195 has two tests. The cost must be paid or incurred in connection with investigating or creating an active trade or business, or in a for-profit activity before the day that business begins, in anticipation of it becoming one. And it must be a cost that would have been deductible if an already-operating business in the same field had paid it.

IRS Tax Tip 2021-166 walks through qualifying examples: an analysis or survey of potential markets, products, labor or transportation; advertisements for the opening; salaries and wages for employees being trained, and their instructors; travel and other necessary costs to secure prospective distributors, suppliers or customers; and salaries or fees for executives, consultants or similar professional services.

Several things are not section 195 startup costs. The statute says the term does not include amounts deductible as interest, taxes, or research and experimental costs under sections 163(a), 164, 174 or 174A. Publication 583 is clear that the cost of a particular asset, such as equipment, is usually depreciated. Inventory is not a startup expenditure. And once the doors are open and you are carrying on the business, ordinary operating costs are generally deducted under the regular business-expense rules, not parked in this 15-year amortization.

Organizational costs, the legal and filing fees to form a corporation or a partnership, are a separate bucket. Publication 583 mentions a separate election to deduct up to $5,000 of organizational costs, also reduced once those costs exceed $50,000, with the rest amortized. That lives under sections 248 and 709, not 195. I’m leaving the details to your CPA so this page doesn’t turn into an entity-formation guide.

The $5,000 deduction, the $50,000 phaseout and 180 months

In the taxable year the active trade or business begins, you deduct the lesser of your startup costs or $5,000, reduced (but not below zero) by the amount those costs exceed $50,000. The remainder is deducted in equal amounts over 180 months, beginning with the month the business begins. Treas. Reg. §1.195-1 says you are generally deemed to have made that election. You can opt out by affirmatively electing to capitalize the costs on a timely filed return, including extensions, for the year the business begins. That choice is irrevocable and applies to all startup costs of that business.

Amortization is reported on Form 4562. If you dispose of the business before the 180 months are up, section 195(b)(2) says remaining deferred expenses may be deducted to the extent allowable under section 165. That’s a facts-and-circumstances question for a CPA, not a promise that leftover costs automatically become a loss.

Here are labeled teaching examples of the math, using a calendar-year business that begins in January, except where noted:

The $8,000 line is straightforward: $5,000 now, plus $3,000 divided by 180, times 12 months, which is $200, for a $5,200 year-one deduction. At $52,000, the $5,000 is reduced by the $2,000 over $50,000, so only $3,000 is immediate. At $55,000, the immediate piece is gone and the whole amount is spread over 15 years.

The month you begin changes the first year. Treas. Reg. §1.195-1, Example 2, uses a corporation that incurs $41,000 of startup costs and begins business in July. It may deduct $5,000 plus the portion of the remaining $36,000 that falls in July through December, which the regulation calculates as $36,000 / 180 × 6, or $1,200, for $6,200 in that first year, and it amortizes the remaining $34,800 over the other 174 months. Don’t annualize a mid-year start as if you had 12 months of amortization.

Investigating a business versus buying one

This is where founders who are shopping for an existing company get surprised. Tax Tip 2021-166 says recoverable startup costs for purchasing an active trade or business include only investigative costs incurred during a general search or preliminary investigation, the costs that help you decide whether to purchase a business. Costs incurred to purchase a specific business are capital expenses that can’t be amortized under section 195.

Rev. Rul. 99-23 makes the same cut. Costs of a general search to decide whether to enter a new business, and which one, can be section 195 investigatory costs. Costs incurred in the attempt to acquire a specific business, including due diligence aimed at closing that deal, are generally capital acquisition costs. If you are further along than “should I be in this industry,” don’t assume the lawyer and accountant bills for the purchase sit in the $5,000 bucket. They often don’t.

If you are starting from zero rather than buying, the pre-opening costs still have to wait for the year the active trade or business begins. Spending money on a logo and a landing page in November does not give you a deduction if you have not actually begun operations. That timing question is also why this belongs in a year-end review with your tax pro, alongside the year-end tax moves every one-person business should make before December 31: the deduction follows the start date, not the date you formed an entity or the date you first spent money.

When the business “begins,” and why a CPA should decide that with you

The $5,000 and the 180-month clock both start with the month the active trade or business begins. Forming an LLC or getting an EIN is not, by itself, the start of operations. Ready to serve customers, with the activity actually underway, is closer to the idea, but the line can be fuzzy. A CPA should help you pick that month with the facts you have, then keep the amortization consistent.

If the venture never becomes an active trade or business, you generally don’t get the section 195 current deduction, because that deduction is for the year the business begins. What happens to the costs then is a different, fact-specific question. Don’t invent a write-off on a project that never opened just because you saw the $5,000 figure on a blog.

My honest take: treat pre-opening spending as a list you will have to classify, not as a pile of regular expenses you can dump on Schedule C the year you thought about starting. Keep receipts. Separate equipment and formation fees from true startup costs. And if you are bootstrapping a startup without investors, don’t assume every dollar you spend before the first customer is immediately deductible. The tax rule is slower than the credit-card bill, and a CPA can keep you from taking the $5,000 too early, or amortizing something that was never a 195 cost at all.

FAQ: Startup costs deduction

What is the startup costs deduction?

It’s the section 195 rule for costs of investigating or creating a business before it opens. In the year the active trade or business begins, you can deduct up to $5,000, then amortize the rest over 180 months.

How much startup costs can I deduct in the first year?

Up to $5,000, plus the first year’s slice of the 180-month amortization, if you begin in that year. The $5,000 shrinks dollar-for-dollar once total startup costs exceed $50,000, and it is zero at $55,000 or more.

What startup costs qualify under section 195?

Typical examples in Publication 583 and Tax Tip 2021-166 include pre-opening advertising, travel, market surveys, and training. The cost must also be one that an already-operating business in the same field could have deducted.

Are equipment and legal formation fees startup costs?

Usually no. Equipment is generally depreciated. Organizational costs to form a corporation or partnership are a separate category, with their own $5,000 election under other Code sections. Ask a CPA to classify them.

Do I have to file an election for section 195?

Generally no. Treas. Reg. §1.195-1 treats you as having elected to amortize when the business begins. To capitalize instead, you must elect that on a timely filed return. The choice is irrevocable.

Can I deduct costs to buy an existing business under section 195?

Only some general investigatory costs, and not the costs of acquiring a specific business. Tax Tip 2021-166 and Rev. Rul. 99-23 treat those purchase costs as capital. This is a CPA question before you allocate the deal bills.

An accountable plan is an employer reimbursement arrangement that can let a company repay an employee, including an S corporation owner-employee, for ordinary business expenses without treating those payments as wages. IRS Publication 463 (for use in preparing 2025 returns) and Treas. Reg. §1.62-2 require three tests: a business connection, adequate substantiation within a reasonable period, and return of any excess reimbursement within a reasonable period. If all three are met, those amounts are excluded from the employee’s gross income, are not reported as wages on Form W-2, and are exempt from federal income-tax withholding and employment taxes.

You’ll also hear it called a reimbursement plan, an expense allowance arrangement or a tax-free reimbursement policy. Same topic. It is not a substitute for a paycheck, and a flat monthly allowance with no receipts usually fails the tests and gets treated as pay. This is education, not tax advice. Talk to a CPA or payroll provider before you adopt a policy.

The three IRS tests, in plain English

Publication 463 is blunt about what has to be in the arrangement. First, the expense must have a business connection: you paid or incurred deductible expenses while performing services as an employee of the employer that’s reimbursing you. A personal dinner or a family flight does not get a new label because the company wrote the check.

Second, you must adequately account to the employer within a reasonable period of time. Publication 463 says that means a statement of expense, an account book, a diary or a similar record, kept at or near the time of the expense, plus receipts or other documentary evidence. Give the company the same support you’d have to give the IRS: the amount, the date, the place and the business purpose, not just a bank-card total.

Third, you must return any excess reimbursement or allowance within a reasonable period of time. If the company advanced you $400 and you adequately accounted for $280, the extra $120 is excess. Either it comes back, or it’s treated as paid under a nonaccountable plan.

All three tests have to be in the arrangement, and the payments have to follow them. Treas. Reg. §1.62-2 also says the business-connection test is not met if the company pays an amount regardless of whether the employee incurs, or is reasonably expected to incur, bona fide business expenses. A fixed stipend that arrives every month whether or not you spent anything has that problem.

What “reasonable period of time” actually means

The IRS says a reasonable period depends on the facts and circumstances. Publication 463 and Treas. Reg. §1.62-2(g) also give safe harbors. Actions inside these windows are treated as timely:

• You receive an advance within 30 days of the time you have an expense.
• You adequately account for your expenses within 60 days after they were paid or incurred.
• You return any excess reimbursement within 120 days after the expense was paid or incurred.
• You are given a periodic statement, at least quarterly, that asks you to return or adequately account for outstanding advances, and you comply within 120 days of the statement.

Those are safe harbors, not a license to dump a shoebox on December 29. If you don’t substantiate on time, or you don’t return the excess on time, Publication 463 says the amount that fails is generally treated as paid under a nonaccountable plan.

Who this is for, and who it isn’t

An accountable plan is an employer-employee arrangement. That is why it comes up once the business is an S corporation or a C corporation and the owner is also on payroll. The company can reimburse the shareholder-employee for ordinary, deductible business expenses paid out of pocket, and those reimbursements stay out of wages if the three tests are met. If you’re still weighing whether that entity even fits, start with S corp vs LLC.

If you operate as a sole proprietor, you generally don’t reimburse yourself through an accountable plan. You deduct ordinary and necessary business expenses on Schedule C. Writing yourself a check from the same Social Security number doesn’t change that. Partnerships have their own rules, so don’t copy an S corporation template into a different entity.

Owner-employees sometimes use an accountable plan to reimburse ordinary costs they pay personally, including a share of home-office expenses or business mileage. Those reimbursements still have to be ordinary, necessary and substantiated under the three tests, and they are not a stand-in for wages. For paying yourself a real salary versus taking distributions, see how to pay yourself as a business owner.

This also matters because unreimbursed employee business expenses are generally no longer a miscellaneous itemized deduction. In Notice 2026-10, the IRS noted that the One Big Beautiful Bill Act made that disallowance permanent for miscellaneous itemized deductions subject to the 2% floor, including unreimbursed employee travel expenses, with only narrow exceptions. If you pay a business cost personally and never get a proper reimbursement, you may have no deduction left on Form 1040.

Mileage and other reimbursements in 2026

Business driving is the example people get sloppy with. A mileage allowance can satisfy the adequate-accounting rule under certain conditions, as Publication 463 explains, but you still need a record of the miles, the dates, the places and the business purpose.

If you use the IRS standard mileage rate, use the rate in force for the date of the travel. The IRS standard mileage rates page, Notice 2026-10 and Announcement 2026-11 set the 2026 business rate at 72.5 cents a mile from January 1 through June 30, and 76 cents a mile from July 1 through December 31. Don’t invent a rate, and don’t keep paying the first-half rate after the mid-year change. Say you drove 200 documented business miles in March 2026 and the plan reimburses at that rate: that’s $145, supported by the log, not by a rounded gas stipend. Actual-expense reimbursement is a different method.

The same discipline applies to travel, lodging, supplies and similar costs you paid on behalf of the company. The expense has to be a deductible business expense, tied to your work as an employee, and documented. This article is not a guide to fringe benefits with special rules for 2-percent S corporation shareholders, such as certain health-plan arrangements.

What happens if the plan fails

A nonaccountable plan, in Publication 463’s terms, is a reimbursement or expense-allowance arrangement that does not meet all three tests. The employer combines those payments with wages and reports the total in box 1 of Form W-2. They are taxable income and, in the usual case, subject to employment taxes.

Two other rules from the same publication are easy to miss. If you are paid under a nonaccountable plan, you can’t convert those amounts by voluntarily handing in receipts after the fact. The arrangement itself has to require the three tests. And even under an accountable plan, any excess you fail to return on time, and any reimbursed expenses that don’t meet the tests, are treated as paid under a nonaccountable plan.

Amounts treated as paid under an accountable plan are, under Treas. Reg. §1.62-2(c)(4), left out of gross income and off the wage line. Excess that isn’t returned, or a payment that never met the tests, is not. If you’re not sure which arrangement you have, ask the person who runs payroll, then have a CPA confirm it against the regulation.

How I would set this up without turning it into a paycheck

I would start with a written policy, even though a written document is not one of the three IRS tests. It should require business-connected expenses, adequate accounting within the 60-day safe harbor, and return of excess advances within the 120-day safe harbor. Then I would actually follow it. A policy in a drawer and a monthly transfer that ignores receipts is still a nonaccountable plan.

I would keep the reimbursement trail separate from payroll. Expense reports, receipts, mileage logs and repayment of excess belong in the books as reimbursements; salary, bonuses and distributions stay in their own lanes. If a payment fails the tests, I would run it through payroll rather than pretend it was tax-free. I would also calendar the 60- and 120-day windows, or use the quarterly-statement safe harbor, so leftover receipts don’t turn a clean reimbursement into wages.

What I would not do is use reimbursements to replace a reasonable salary, or to move personal spending onto the company. An accountable plan can keep a real business expense from being stuck in your personal account with no deduction. That is for ordinary costs after the company is operating. Bills you paid while investigating or creating the business are a different category: startup costs incurred before the business opened. It cannot turn a paycheck into a tax-free allowance. Get a CPA, and if you have staff, a payroll provider, to review the policy and the first few cycles of reports.

I’m not your tax advisor, and this isn’t advice for your return. The tests and safe harbors come from IRS Publication 463 (for use in preparing 2025 returns) and Treas. Reg. §1.62-2. The 2026 mileage rates come from the IRS standard mileage rates page, Notice 2026-10 and Announcement 2026-11. Use them with a CPA who can apply the rules to your entity.

Frequently asked questions

What is an accountable plan?

It’s an employer reimbursement arrangement that meets three IRS tests: a business connection, adequate substantiation within a reasonable period, and return of any excess reimbursement within a reasonable period. Qualifying payments are excluded from wages.

What are the IRS accountable plan time limits?

A reasonable period depends on the facts. Publication 463 treats these safe harbors as timely: advances within 30 days, substantiation within 60 days after the expense, and return of excess within 120 days. A quarterly statement with 120 days to comply is another safe harbor.

Are accountable plan reimbursements taxable?

If the arrangement meets all three tests, Treas. Reg. §1.62-2 says the payments are excluded from gross income, are not reported in box 1 of Form W-2, and are exempt from federal employment taxes. Payments that fail the tests are generally treated as wages.

Can a sole proprietor use an accountable plan to reimburse themselves?

Generally no. An accountable plan is an employer-employee arrangement. A sole proprietor typically deducts ordinary business expenses on Schedule C instead of reimbursing themselves.

What is the 2026 IRS mileage rate for an accountable plan?

The IRS business standard mileage rate is 72.5 cents a mile from January 1 through June 30, 2026, and 76 cents a mile from July 1 through December 31, 2026. You still need a mileage log.

What happens if I don’t return an excess reimbursement?

Publication 463 says the excess is treated as paid under a nonaccountable plan. Your employer generally includes it in box 1 of Form W-2, and it is handled as wages.