This month, the IRS issued Rev. Rul. 2012-25, which provides four detailed examples of what types of arrangements qualify to be excluded from tax under the Sec. 62(c) “accountable plan” rules.
As discussed in Regs. Sec. 1.62-2(c)(4), amounts paid under an accountable plan are generally excluded
from a recipient employee’s taxable income and are therefore exempt from payroll taxes and income taxes. Amounts paid under a nonaccountable plan (or under an improperly maintained accountable plan) will result in additional income on the employee’s Form W-2, Wage and Tax Statement, with withholding and additional payroll taxes due. (For more on the accountable plan rules, see Christian, "Tax Advantaged 'Accountable Plans' for Employee Business Expenses," Corporate Taxation Insider (July 29, 2010).)
To illustrate, if a company provides certain employees with an automobile allowance that is operated outside of the accountable plan rules, a $500 per month/$6,000 per year auto allowance would cost the employer and employee up to nearly $3,000 in additional income and payroll taxes:
As this example shows, the savings from properly structured reimbursement arrangements can have a beneficial impact on businesses (and their employees) with large sales and service forces.
To take advantage of the accountable plan rules, employers must establish a valid, written plan in accordance with Sec. 62(a)(2)(A) and Regs. Sec. 1.62-2. To qualify as an accountable plan, the plan must require that:
Under the business connection requirement, not only must each participating employee actually pay or incur a deductible business expense, but the expense also must arise in connection with the employment for that specific employer. In other words, an employee cannot use the funds for a business purpose outside the employer’s purpose.
Rev. Rul. 2012-25 provides guidance on the business connection requirement. Following is a brief synopsis of the examples in the revenue ruling and the reason the plan passed or failed:
Example 1: Employer A is a company that employs field technicians who install cable television systems for a variety of cable companies. The technicians are required to provide their own tools and equipment necessary to complete the jobs. The technicians were originally paid on an hourly basis, which took into account that they were required to provide their own tools. Employer A then decides to reimburse the technicians for the tools and decreases their hourly compensation rate based on a calculated “hourly tool rate.” Employer A treats the reduced hourly compensation rate as taxable wages and the tool rate as a nontaxable reimbursement, which is approximately the preplan hourly rate on a combined basis. Once the employee has been compensated for the tools he requires, his hourly rate is increased to the preplan level.
Ruling: Employer A’s plan is not an accountable plan. The tool plan does not satisfy the business connection requirement (Regs. Sec. 1.62-2(d)(3)(i)) of the accountable plan rules because the employer pays the same gross amounts to all the technicians. The tool reimbursements are a recharacterization of wages because the same amount is paid with or without the tool reimbursement plan. This is a very similar fact pattern to Chief Counsel Advice 201120021.
Example 2: Employer B is a staffing contractor that employs nurses who provide services to hospitals throughout the country. Employer B compensates all nurses on an hourly basis that does not vary based on location. When the nurses go to hospitals away from their tax home, Employer B treats a portion of the nurses’ hourly compensation as a nontaxable per diem allowance for lodging, meals, and incidental expenses. When Employer B sends the nurses to hospitals within commuting distance, all compensation is treated as taxable.
Ruling: Employer B’s plan is not an accountable plan. Similar to Example 1, the per diem plan does not satisfy the business connection requirement because Employer B pays the same gross amount to nurses regardless of whether the nurses incur travel expenses.
Example 3: Employer C is a construction firm that employs workers to build commercial buildings. Some of the workers are required to use their personal vehicles to travel between construction sites. Employer C compensates all of its workers on an hourly basis, which is treated as taxable wages. In addition, Employer C pays all its workers a flat amount per pay period for use of their personal vehicles and treats it as a nontaxable mileage reimbursement.
Ruling: Employer C’s mileage reimbursement plan does not qualify as an accountable plan. The plan does not satisfy the business connection requirement of the accountable plan rules because it pays a mileage reimbursement to all workers, including those who may not actually incur deductible business expenses. The mileage reimbursement is again simply recharacterized wages because all workers receive the reimbursement regardless of whether they incur the mileage expenses.
Example 4: Employer D employs workers to perform housecleaning services. Employees are required to provide the cleaning products and equipment necessary to complete the cleaning jobs they are assigned. Employer D compensates its employees on an hourly basis, which takes into account that the employees are required to provide their own cleaning products and equipment. Employer D decides to begin reimbursing its employees for their cleaning and equipment expenses. Employer D alters the compensation structure by reducing the hourly compensation paid to all employees. Employees must substantiate the actual amount of deductible expenses incurred in purchasing their cleaning products and equipment. Employees who do not incur expenses, or who do not properly substantiate expenses to Employer D, continue to receive the lower hourly compensation, do not receive any reimbursement, and are not compensated in any other way. Employer D treats the hourly compensation as taxable wages and the cleaning and equipment expenses as nontaxable reimbursements.
Ruling: Employer D’s reimbursement agreement qualifies as an accountable plan. The plan satisfies the business connection requirement of the accountable plan rules. Employer D’s plan reimburses employees only when a deductible business expense has been incurred in connection with performing services for Employer D. Employer D reduced the amount of compensation it pays to all of its employees, but the reduction in compensation is a substantive change in Employer D’s compensation structure. The reimbursement amounts are not guaranteed, and employees who do not incur expenses or who do not properly substantiate expenses continue to receive the reduced hourly compensation amount.
As you can see, the IRS is very focused on the underlying economics of the advance/reimbursement arrangements and requires a full accounting of how the funds are spent on business items.
Employers should not be dissuaded from establishing an accountable plan just because only one of the four examples survived scrutiny. A properly structured plan will be respected. Accountable plans can offer significant operating savings and a happier workforce. However, prudent drafting of the arrangement and sound administrative compliance is critical to ensure tax-free treatment of the arrangements.
As discussed in Regs. Sec. 1.62-2(c)(4), amounts paid under an accountable plan are generally excluded
from a recipient employee’s taxable income and are therefore exempt from payroll taxes and income taxes. Amounts paid under a nonaccountable plan (or under an improperly maintained accountable plan) will result in additional income on the employee’s Form W-2, Wage and Tax Statement, with withholding and additional payroll taxes due. (For more on the accountable plan rules, see Christian, "Tax Advantaged 'Accountable Plans' for Employee Business Expenses," Corporate Taxation Insider (July 29, 2010).)
To illustrate, if a company provides certain employees with an automobile allowance that is operated outside of the accountable plan rules, a $500 per month/$6,000 per year auto allowance would cost the employer and employee up to nearly $3,000 in additional income and payroll taxes:
Employer
|
Employee
| |
| Tax base |
$6,000
|
$6,000
|
| Social Security tax (6.2%/4.2%) |
$372
|
$252
|
| Medicare tax (1.45%/1.45%) |
$87
|
$87
|
| Federal tax @ 30% (average) |
N/A
|
$1,800
|
| State tax @ 6% (average) |
N/A
|
$360
|
| Total incremental tax costs |
$459
|
$2,499
|
As this example shows, the savings from properly structured reimbursement arrangements can have a beneficial impact on businesses (and their employees) with large sales and service forces.
To take advantage of the accountable plan rules, employers must establish a valid, written plan in accordance with Sec. 62(a)(2)(A) and Regs. Sec. 1.62-2. To qualify as an accountable plan, the plan must require that:
- The employee expenses have a business connection;
- The employee adequately account for the expenses within a reasonable time period; and
- The employee return excess allowances within a reasonable period of time.
- Advances are received within 30 days of the time the expense is paid or incurred.
- Expenses are adequately accounted for within 60 days after they were paid or incurred.
- Any excess reimbursement is returned within 120 days after the expense was paid or incurred.
Under the business connection requirement, not only must each participating employee actually pay or incur a deductible business expense, but the expense also must arise in connection with the employment for that specific employer. In other words, an employee cannot use the funds for a business purpose outside the employer’s purpose.
Rev. Rul. 2012-25 provides guidance on the business connection requirement. Following is a brief synopsis of the examples in the revenue ruling and the reason the plan passed or failed:
Example 1: Employer A is a company that employs field technicians who install cable television systems for a variety of cable companies. The technicians are required to provide their own tools and equipment necessary to complete the jobs. The technicians were originally paid on an hourly basis, which took into account that they were required to provide their own tools. Employer A then decides to reimburse the technicians for the tools and decreases their hourly compensation rate based on a calculated “hourly tool rate.” Employer A treats the reduced hourly compensation rate as taxable wages and the tool rate as a nontaxable reimbursement, which is approximately the preplan hourly rate on a combined basis. Once the employee has been compensated for the tools he requires, his hourly rate is increased to the preplan level.
Ruling: Employer A’s plan is not an accountable plan. The tool plan does not satisfy the business connection requirement (Regs. Sec. 1.62-2(d)(3)(i)) of the accountable plan rules because the employer pays the same gross amounts to all the technicians. The tool reimbursements are a recharacterization of wages because the same amount is paid with or without the tool reimbursement plan. This is a very similar fact pattern to Chief Counsel Advice 201120021.
Example 2: Employer B is a staffing contractor that employs nurses who provide services to hospitals throughout the country. Employer B compensates all nurses on an hourly basis that does not vary based on location. When the nurses go to hospitals away from their tax home, Employer B treats a portion of the nurses’ hourly compensation as a nontaxable per diem allowance for lodging, meals, and incidental expenses. When Employer B sends the nurses to hospitals within commuting distance, all compensation is treated as taxable.
Ruling: Employer B’s plan is not an accountable plan. Similar to Example 1, the per diem plan does not satisfy the business connection requirement because Employer B pays the same gross amount to nurses regardless of whether the nurses incur travel expenses.
Example 3: Employer C is a construction firm that employs workers to build commercial buildings. Some of the workers are required to use their personal vehicles to travel between construction sites. Employer C compensates all of its workers on an hourly basis, which is treated as taxable wages. In addition, Employer C pays all its workers a flat amount per pay period for use of their personal vehicles and treats it as a nontaxable mileage reimbursement.
Ruling: Employer C’s mileage reimbursement plan does not qualify as an accountable plan. The plan does not satisfy the business connection requirement of the accountable plan rules because it pays a mileage reimbursement to all workers, including those who may not actually incur deductible business expenses. The mileage reimbursement is again simply recharacterized wages because all workers receive the reimbursement regardless of whether they incur the mileage expenses.
Example 4: Employer D employs workers to perform housecleaning services. Employees are required to provide the cleaning products and equipment necessary to complete the cleaning jobs they are assigned. Employer D compensates its employees on an hourly basis, which takes into account that the employees are required to provide their own cleaning products and equipment. Employer D decides to begin reimbursing its employees for their cleaning and equipment expenses. Employer D alters the compensation structure by reducing the hourly compensation paid to all employees. Employees must substantiate the actual amount of deductible expenses incurred in purchasing their cleaning products and equipment. Employees who do not incur expenses, or who do not properly substantiate expenses to Employer D, continue to receive the lower hourly compensation, do not receive any reimbursement, and are not compensated in any other way. Employer D treats the hourly compensation as taxable wages and the cleaning and equipment expenses as nontaxable reimbursements.
Ruling: Employer D’s reimbursement agreement qualifies as an accountable plan. The plan satisfies the business connection requirement of the accountable plan rules. Employer D’s plan reimburses employees only when a deductible business expense has been incurred in connection with performing services for Employer D. Employer D reduced the amount of compensation it pays to all of its employees, but the reduction in compensation is a substantive change in Employer D’s compensation structure. The reimbursement amounts are not guaranteed, and employees who do not incur expenses or who do not properly substantiate expenses continue to receive the reduced hourly compensation amount.
As you can see, the IRS is very focused on the underlying economics of the advance/reimbursement arrangements and requires a full accounting of how the funds are spent on business items.
Employers should not be dissuaded from establishing an accountable plan just because only one of the four examples survived scrutiny. A properly structured plan will be respected. Accountable plans can offer significant operating savings and a happier workforce. However, prudent drafting of the arrangement and sound administrative compliance is critical to ensure tax-free treatment of the arrangements.
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