Tax & Accounting Blog

IRS Revenue Ruling highlights expense payments which cannot be tax-free

1099, ONESOURCE, Tax Information Reporting, Withholding Management September 19, 2012

Revenue Ruling 2012-25 from the Internal Revenue Service describes three plans which companies set up to provide expense reimbursements to employees, with the payments treated as outside of the wage stream and therefore paid without any tax deductions and not reported on the employees’ W-2 forms.  But under IRS scrutiny, all three plans failed the test of the tax regulations for expense reimbursement.  The payments made to employees under these plans were taxable wages after all.  Or in IRS language, these were arrangements which “impermissibly recharacterize wages, such that the arrangements are not accountable plans.”  The Revenue Ruling also describes one plan which meets the regulatory requirements so the payments can be excluded from taxable wage treatment.

Plan 1, reimbursing for tool expenses.  The employer calculated an “hourly tool rate” and treated that as a nontaxable expense reimbursement because the employees provided their own tools.  The employer also paid an hourly wage rate of taxable compensation.  However, all employees received the same gross hourly amount (tool rate plus wage rate) without regard to specific expenses incurred relating to the employer’s business.  Therefore the plan failed the “business connection” requirement of the tax regulations sec. 1.62-2(d), and even without regard to the accountable plan expense requirements, the plan was merely a recharacterization of wages.  The “hourly tool rate” was simply wages by another name.

Plan 2, paying per diem travel allowances to nurses.  The employer was a staffing contractor which assigned nurses to various medical facilities for short-term assignments.  On some assignments, the employer treated a portion of the nurses’ hourly compensation as a nontaxable per diem allowance for lodging, meals and incidental expenses.  However, the gross compensation per hour for those traveling assignments (“wage” plus per diem) was always the same as the total compensation per hour for assignments without travel (“wage” only).  Therefore the plan failed the “business connection” requirement of the tax regulations sec. 1.62-2(d), and even without regard to the accountable plan expense requirements, the per diem plan was merely a recharacterization of wages.

Plan 3, paying mileage reimbursements for travel between job sites.  The employer required some of its employees to travel between construction sites or otherwise use their personal vehicles for business purposes.  But instead of reimbursing at a mileage rate based on substantiation of the travel (date, miles, business purpose), the employer paid all of its workers (including some who were not required to travel or otherwise use their personal vehicles) a flat amount per day which it treated as a nontaxable mileage reimbursement.  Therefore, the purported mileage reimbursement was merely recharacterized wages because all workers receive an amount regardless of whether they incurred mileage expenses.  The plan failed to satisfy the “business connection” requirement of the tax regulations sec. 1.62-2(d).

Plan 4, a permissible expense reimbursement plan which meets the requirements.  The employer pays an hourly wage to its workers, and in addition it reimburses workers for their expenses of furnishing cleaning products and equipment necessary to perform the cleaning-service jobs to which the employer assigns them.  Employees must provide substantiation of their expenses in order to receive reimbursement.  No “expense allowances” are paid; expense reimbursement is based entirely upon substantiation.  Employees who do not furnish proper substantiation of expenses do not receive reimbursements; their payments from the employer are limited to their hourly wages.  This expense reimbursement plan satisfies the “business connection” requirement of the tax regulations sec. 1.62-2(d) and therefore, as long as the accountable plan requirements for substantiation of expenses and return of excess amounts are met, the expense reimbursements are nontaxable.