IRS targets tool reimbursement plans that recharacterize wages
Employee Tool & Equipment Alert
on IRS’s website https://www.irs.gov/businesses/article/0,,id=178028,00.html
IRS has established a cross divisional team to address significant concerns with employee tool and equipment plans that purport to be valid accountable plans. Taxpayers that are considering implementing these plans, which are widely marketed to various industries, including the automotive, heavy equipment, construction, aircraft maintenance, agriculture, and other industries, are cautioned to be wary of them.
Background on accountable-plan rules. Reimbursements are tax-free to the employee and aren’t subject to withholding or payroll taxes if made under an accountable plan. To be treated as made under an accountable plan, a reimbursement must meet all of the following requirements:
(1) The reimbursed expense must be allowable as a deduction and must be paid or incurred in connection with performing services as an employee of the employer; (Reg. § 1.62-2(d)(1))
(2) Each reimbursed expense must be adequately accounted for to the employer within a reasonable period of time; (Reg. § 1.62-2(e)) and
(3) Any amounts in excess of expenses must be returned within a reasonable period of time. (Reg. § 1.62-2(f))
If a payor’s reimbursement or other expense allowance arrangement shows a pattern of abuse, all payments made under the arrangement are treated as made under a nonaccountable plan (and thus are taxable wages, subject to withholding). (Reg. § 1.62-2(k))
In Rev Rul 2006-56, 2006-46 IRB 874, IRS concluded that an employer’s reimbursement for business-travel-related meals and incidental expenses (M&IE) evidenced a pattern of abuse under Reg. § 1.62-2(k). The employer didn’t track expenses and didn’t require employees either to actually substantiate expenses or pay back amounts in excess of the deemed substantiated amount. As a result, all of the M&IE reimbursements–not just the excess reimbursements above the deemed substantiation amount–were treated as nonaccountable plan payments (and so wages).
IRS takes aim at faulty reimbursement plans. Despite their claims to the contrary, many tool plans currently being marketed to employers do not meet the requirements for an accountable plan. On its website, IRS has published an “Employee Tool & Equipment Alert,” advising employers that IRS has established a cross divisional team to address significant concerns with employee tool and equipment plans–sometimes called Service Technician’s Tool Reimbursement Plans–that purport to be tax-favored accountable plans. The team includes members of all examination divisions, Appeals, and the Office of Chief Counsel. IRS has also initiated promoter investigations and employer examinations identified from promoter client lists. IRS says that to the extent that plans do not meet the accountable plan rules, there will be employment tax and potentially penalty assessments.
The majority of plans being marketed are designed and operated around a structure that recharacterizes a portion of the employee’s existing pay as a “reimbursement” for the employee’s tools merely to generate tax savings for both the employer and the employee. Under such a plan, the employee continues to receive the same gross pay that he had received but a portion of it that was previously treated as taxable compensation is recharacterized as nontaxable tool expense reimbursement. IRS stresses that the accountable plan rules clearly provide that amounts that are paid whether or not there are expenses incurred are not reimbursements and are not eligible for accountable plan treatment.
Observation: These tool plan reimbursement arrangement are generally marketed as a win-win deal for all involved. The promoter of the plan may receive a fee for administering the plan, and the employer and employee get to treat part of the employee’s compensation as nontaxable, subject to neither income nor FICA tax withholding.
IRS is also currently revising the 2000 Coordinated Issue Paper, Service Technicians’ Tool Reimbursement Programs (which dealt with motor vehicle service technicians and tool plan typically operated at that time, see Federal Taxes Weekly Alert 08/03/2000) to reflect facts consistent with plans currently being marketed.
Observation: This is the latest move in IRS’s battle against suspect reimbursement plans. In Chief Counsel Advice 200745018, IRS determined that a similar tool reimbursement plan that recharacterized wages failed the business connection, substantiation, and return of excess payment requirements for an accountable plan and might have demonstrated a pattern of abuse (see Federal Taxes Weekly Alert 11/15/2007). In Rev Rul 2005-52, 2005-2 CB 423, IRS also attacked a tool allowance plan paid to auto mechanics based on estimated, rather than actual expenses, finding it failed the substantiation and return of excess payment requirements.