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The IRS has clarified when arrangements to recharacterize taxable wages as nontaxable reimbursements fail to satisfy IRS Code Sec. 62(c).

IRS Says When Wages Can Be Recharacterized As Nontaxable Reimbursements

  • 9/26/2012

IRS Says When Wages Can Be Recharacterized As Nontaxable Reimbursements

The IRS has clarified when arrangements to recharacterize taxable wages as nontaxable reimbursements fail to satisfy Code Sec. 62(c) accountable plan rules. Four reimbursement arrangements were used as examples.

CCH Take Away: In recent years, the IRS has had tool plans on its radar. Tool plans are popular in industries requiring workers to provide their own tools. The plans purport to receive tax-favored treatment as accountable plans under Code Sec. 62(c).

Arrangement #1

Employer A pays its technicians on an hourly basis, taking into account that technicians provide their own tools. The employer begins reimbursing the technicians for tool expenses through a tool reimbursement arrangement. To arrive at an hourly tool rate, the employer takes the technician's total annual expenses and divides the amount by the number of hours a technician is expected to work over the year. Technicians receive a reduced hourly compensation rate, treated as taxable wages, and an hourly tool rate, treated as a nontaxable reimbursement. Once a technician has received payments for the total amount of tool expenses, Employer A ceases paying the technician an hourly tool rate but increases the technician's hourly compensation to the pre-tool plan hourly compensation rate.

The IRS determined that Employer A’s tool plan is not an accountable plan since it pays the same gross amount to a technician regardless of whether the technician incurs, or is reasonably expected to incur, expenses related to its business. The purported tool reimbursements are merely recharacterized wages.

Arrangement #2

Employer B hires nurses who work short-term for hospitals. When the nurses travel away from home, the employer treats a portion of their hourly compensation as a nontaxable per diem allowance for lodging, meals, and incidental expenses under the employer’s per diem plan. The employer treats the remaining portion of the nurses’ hourly compensation as taxable wages. When nurses are sent on assignment to hospitals within commuting distance of their tax home, their employer treats all of their compensation as taxable wages. In each case, the nurses receive the same total hourly compensation.

The IRS determined that the per diem plan is not an accountable plan. Employer B pays the same gross amount to nurses regardless of whether the nurses incur, or are reasonably expected to incur, travel expenses related to its business. The purported per diem payments are merely recharacterized wages.

Arrangement #3

Employer C hires construction workers. Some workers must travel between construction sites or use their personal vehicles for business purposes. All employees are compensated on an hourly basis, which the employer treats as taxable wages. The employers also pays all workers, including employees not required to travel or use their personal vehicles for company business, a flat amount per pay period, which it treats as a nontaxable mileage reimbursement.

The IRS determined that the mileage reimbursement plan is not an accountable plan. Employer C routinely pays an amount as a mileage reimbursement to workers who have not incurred, and are not reasonably expected to incur, deductible business expenses in connection with its business. The purported mileage reimbursement is merely recharacterized wages.

Arrangement #4

Employer D hires cleaners who provide their own cleaning products, which the employer takes into account for their hourly pay. Employer D begins reimbursing its employees for their cleaning product expenses through a reimbursement arrangement, and prospectively alters its compensation structure by reducing the hourly compensation paid to all employees. Those who substantiate the actual amount of expenses for their cleaning products are reimbursed. Employees who do not incur expenses for cleaning products, or who fail to properly substantiate their expenses, continue to receive the lower hourly compensation. The employer treats the hourly compensation as taxable wages and the payments for cleaning expenses as nontaxable reimbursements.

The IRS determined that the reimbursement arrangement is an accountable plan. Employer D only reimburses employees when a deductible business expense has been incurred and the reimbursement is not in lieu of wages that the employees would otherwise receive.

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