IRS warns taxpayers about frivolous return arguments

Due to a significant amount of tax promoters marketing what they claim are fully compliant accountable plans (expense accounts that follow strict substantiation and payment rules), members of the IRS examination divisions, Appeals and Office of Chief Counsel are forming a cross-divisional team within the IRS to combat abuse of Code Sec. 62(c) accountable plans that provide tax-free employer reimbursement of the cost of employees’ tools and equipment. Of particular concern to the IRS is the apparent design and operation of tool plans to recharacterize a portion of compensation otherwise payable to the employee rather than reimburse substantiated expenses incurred for the employer.  

A recently revised “Employee Tool & Equipment Alert,” which is available on the IRS’s website (www.irs.gov) explains expense reimbursement plans under Code Sec. 62(c), and the types of arrangements that are cause for heightened concern. Employers considering the implementation of accountable plans should use caution.

Expense reimbursement plans

An expense reimbursement arrangement will qualify as a tax-favored accountable plan if it satisfies three requirements: business connection, substantiation and returning amounts in excess of substantiated expenses. Additionally, the arrangement must not evidence a pattern of abuse of rules applicable to such plans.

If the arrangement complies with these requirements, amounts treated as paid under an accountable plan are excluded from an employee’s gross income, are not reported as wages on Forms W-2 and are exempt from withholding and payment of employment taxes. But if the arrangement fails any of the requirements or is abusive, amounts paid under the plan are treated as paid under a nonaccountable plan, are included in an employee’s gross income, must be reported as wages or other compensation on Form W-2, and are subject to withholding and payment of employment taxes.

Tools and equipment

Recently, the IRS has discovered that a growing number of plans are attempting to recharacterize a portion of the employee’s existing wages as “reimbursement” for tools and equipment in order to take advantage of the accountable plan’s tax benefits, particularly the avoidance of social security and other payroll taxes. The IRS quickly made clear that it will not accept this argument. Because an employee’s wages would have been paid, whether or not the tools were purchased, the IRS is making it clear that payments are not a reimbursement and is therefore ineligible for accountable plan treatment.

The problem with the latest accountable plan clamp down is not only that some employers are being taken in by promoters over this “can’t lose” tax technique – as businesses, they will be subject to back taxes and penalties nonetheless. The problem also is that the IRS is launching a general campaign in which it is looking closely at all accountable plans, making certain all the t’s are crossed and the i’s dotted. 

Please feel free to call this office if you’d like us to give your accountable plan a check up to avoid either of these situations.

(LTR 200745018)