Revision: January 30, 2008
IRS Convenes Cross Divisional Team to Consider Employee Tool & Equipment Plans
The Internal Revenue Service has established a cross divisional team to address significant concerns with certain Employee Tool and Equipment Plans, sometimes called Service Technician’s Tool Reimbursement Plans, that purport to receive tax-favored treatment as “accountable plans” under Internal Revenue Code § 62(c) and the accompanying regulations.
An expense reimbursement arrangement is a tax-favored accountable plan if it satisfies the three requirements of business connection, substantiation, and returning amounts in excess of substantiated expenses, and if it does not evidence a pattern of abuse of the rules applicable to such plans. Amounts treated as paid under an accountable plan are excluded from the employee’s gross income, are not reported as wages on the employee’s Form W-2, and are exempt from withholding and payment of employment taxes. Conversely, if the arrangement fails any of the requirements or otherwise evidences a pattern of abuse of the rules, the amounts paid under the arrangement are treated as paid under a “nonaccountable plan” and are included in the employee’s gross income, must be reported as wages or other compensation on the employee’s Form W-2, and are subject to withholding and payment of employment taxes.
Many of the tool plans currently being marketed do not meet the requirements to be tax-favored accountable plans despite their claims to the contrary. In addition to its concerns with the lack of substantiation provided by the technicians to ensure that only expenses incurred for that employer are included in the plan, the Service is focusing on the fact that the majority of the 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. In other words, the employee continues to receive the same gross pay but what was previously paid as taxable compensation is recharacterized as nontaxable reimbursement until the employee’s alleged tool costs have been recovered, then the employee returns to his original amount of taxable compensation. The accountable plan rules make clear that amounts paid whether or not there are expenses incurred are not reimbursements and are not eligible for tax-favored treatment.
The Service’s attention to tool plans is not new. In 2000, the Service issued a Coordinated Issue Paper, Service Technicians’ Tool Reimbursement Plans. The Coordinated Issue Paper concluded that “…generally, amounts paid to motor vehicle service technicians as tool reimbursements will not meet the accountable plan requirements.” Although directed specifically at motor vehicle service technicians, the conclusion of the Coordinated Issue Paper was consistent with fact patterns also found in other industries. In 2005, Revenue Ruling 2005-52 addressed the tax consequences of a tool plan, as typically operated at that time. The ruling concluded that the arrangement failed to meet both the substantiation and return of excess requirements and therefore was not a tax-favored accountable plan. While the tool plan promoters responded to the revenue ruling by changing elements of their plans to address some of the shortcomings regarding the substantiation of expenses, the Service continues to be concerned about the currently marketed tool plans. Of particular concern to the Service is the apparent design and operation of the tool plans to recharacterize a portion of the compensation otherwise payable to the employee rather than reimburse substantiated expenses incurred for the employer. The Service’s cross-divisional team includes members of all examination divisions, Appeals, and the Office of Chief Counsel. The Service has also initiated promoter investigations and employer examinations identified from promoter client lists. To the extent that plans do not meet the accountable plan rules, there will be employment tax and potentially penalty assessments. The Service is also currently revising the 2000 Coordinated Issue Paper, Service Technicians’ Tool Reimbursement Programs, to reflect facts consistent with plans currently being marketed.
These plans are widely marketed to various industries, including the automotive, heavy equipment, construction, aircraft maintenance, agriculture, and other industries. Taxpayers that are considering implementing such a plan are advised to take a cautious approach.