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Guest Article

Deloitte logo

(From the July 11, 2011 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

"Accountable Plan" Reimbursements May Not Substitute for Wages


In a recent Chief Counsel Advice Memorandum, the IRS underscored that reimbursements under an accountable plan cannot serve as a substitute for amounts that would otherwise be paid as taxable wages. An accountable plan must satisfy a "business connection" requirement by which only deductible business expenses incurred by the employee in connection with the employment are reimbursed. If the amounts will be paid regardless of whether the expenses are incurred (i.e., will be paid in any event as either wages or reimbursements) the business connection requirement is not met and the arrangement fails to be "accountable plan" under Code § 62.

Exclusion from Gross Income for "Accountable Plans"

Code § 61 defines gross income as all income from whatever source, while Code § 62 defines adjusted gross income as gross income minus certain deductions. Treasury Regulations under Code § 62(c) provide that employer reimbursement of employee business expenses that are paid in connection with the employment is excluded from the employee's gross income if the reimbursement is provided under an "accountable plan." A reimbursement or expense allowance arrangement is an "accountable plan" if it satisfies the requirements of business connection, substantiation, and requires the employee to return amounts in excess of the substantiated expenses.

Amounts paid by an accountable plan are excluded from the employee's gross income, exempt from withholding and payment of employment taxes, and are not reported as wages on the employee's form W-2. In contrast, if the amounts are treated as paid under a non-accountable plan, they must be included in the employee's gross income for the taxable year, are subject to withholding and payment of employment taxes, and must be reported as wages or other compensation on Form W-2.

Tool Plan Does not Qualify as an Accountable Plan

In CCA201120021, the employer's reimbursement plan was a tool plan intended to reimburse employees for the use of their tools and equipment. Payments under the plan were made to the employees as a nontaxable reimbursement for the cost of the tools the employees were required to provide as a condition of their employment. While the CCA discussed various aspects of the tool plan that presented issues with its being considered an "accountable plan" (e.g., the method for determining the expenses incurred by employees for those tools that had been purchased before enrollment in the reimbursement plan), the critical aspect was the way an employee's taxable wages were adjusted while he or she was enrolled in the tool plan.

Once enrolled in the plan, an employee's wages was split into two separate components: reduced hourly wages and a tool plan payment which was calculated as a set percentage of the employee's hourly wage. Two separate checks were issued: one for the reduced hourly wage amount, and a second for the tool payment which was treated as not subject to employment taxes. The enrolled employees would continue to receive essentially the same amount per hour as they did prior to their enrollment in the tool plan, but the portion consisting of tool reimbursement was treated as nontaxable. Once the employee received tool reimbursements equal to the full amount to be reimbursed (i.e., the value or estimated cost of the employee's tools and equipment), the reimbursements stopped and the employee was returned to his or her regular pay at the hourly rate he or she earned before enrolling in the tool plan.

Treasury Regulations and Legislative History

The IRS focused on Treasury Regulation § 1.62-2(d)(3)(i), which states that the "business connection" requirement for accountable plans will not be satisfied if amounts are paid to an employee regardless of whether the employee incurs (or is reasonably expected to incur) deductible business expenses related to the employment. The IRS explained:

[A]n employer may not structure its compensation arrangement so as to avoid the payment of employment taxes by substituting reimbursements and expense allowances for amounts that would otherwise be paid as wages, as illustrated by a temporary reduction in an hourly wage amount only for as long as the tool rate amount is paid. Such recharacterization violates the business connection requirement of Treas. Reg.§ 1.62-2(c) because the employee receives the same amount regardless of whether expenses were incurred or reasonably expected to be incurred.

The IRS also referenced the legislative history of Code § 62(c) which, after the Tax Reform Act of 1986 (TRA), permits an above-the-line deduction only for expenses that are reimbursed under an "accountable plan" because such expenditures are paid out of business earnings in addition to amounts that are otherwise paid as wages. The employer in that circumstance has an incentive to require sufficient substantiation according to Congress. The TRA changed the rules for deducting employee business expenses by converting most of those expenses into itemized deductions which the taxpayer can deduct only if the expenses in the aggregate exceed two percent (2%) of gross income. Congress at that time specifically rejected an above-the-line deduction for reimbursements made under a nonaccountable plan because such a plan could easily circumvent the two percent (2%) floor "solely by restructuring the form of the employee's compensation so that the salary amount is decreased, but the employee receives an equivalent nonaccountable expense allowance." Congress's intention, therefore, was not to allow an above-the-line deduction for reimbursement plans that essentially restructure wages as reimbursements.


Deloitte logoThe information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations.

If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact:

Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Mary Jones 202.378.5067, Stephen LaGarde 202.879-5608, Erinn Madden 202.220.2692, Bart Massey 202.220.2104, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Deborah Walker 202.879.4955.

Copyright 2011, Deloitte.


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