Employee Tool and Equipment Plans - John R. Dundon II, Enrolled Agent
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Employee Tool and Equipment Plans

Business Entity Selection and the Tax Consequences of Converting

Employee Tool and Equipment Plans

Tool and Equipment Plans generally require employees to provide their own tools. Some plans purport to receive tax-favored treatment as “accountable plans” under the definition of adjusted gross income in Internal Revenue Code § 62(c).

If you are expected to use your own tools and equipment on the job and get reimbursed be very careful in understanding the definition of an “accountable plan” because the Internal Revenue Service has established a compliance team to address significant concerns with certain Employee Tool and Equipment Plans that purport to receive tax-favored treatment as accountable plans. It’s all spelled out in the Alert.

Here’s the facts as I understand.

1. According to ILM 201120021 a reimbursement or other expense allowance arrangement that pays an amount regardless of whether an expense is paid or incurred or reasonably expected to be paid or incurred by the employee in performing services for the employer violates the business connection requirement of an accountable plan under Treas. Reg. § 1.62-2(d)(3)(i). Accordingly, payments made under the arrangement are treated as made under a nonaccountable plan. Amounts treated as paid under a nonaccountable plan 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 the employee’s Form W-2.

2. The IRS’ Chief Counsel issued the following Advice – ILM 200745018 concluding that an employer’s tool reimbursement plan does not satisfy the requirements of an accountable plan.

3. IRS Revenue Ruling 2005-52 holds that tool allowances paid to employees are not paid under an accountable plan because the substantiation and return of excess requirements are not met.

4. A Coordinated Issue Paper Revised on July 2,2008 concludes  that Employee Tool and Equipment Plans  under which amounts are paid to employees for the use of their tools and equipment, do not meet the accountable plan requirements.

5. An IRS Private Letter Ruling (200930029) states that an employer’s expense reimbursement plan satisfies the business connection, substantiation, and return of excess requirements of an accountable plan.  Payments made under the Plan were allowed exclusion from the Technician’s income and not considered wages subject to the withholding and payment of employment taxes because the Plan only reimbursed covered costs that the Technician substantiated.

If you are an employer that requires your employees to provide their own tools you may want to review and understand this private letter ruling and only provide reimbursement for tool expense upon written substantiation (aka receipt). It is best practice to understand the nuances of accountable and nonaccountable tool and equipment plans.

A blanket payment made to an employee on a regular and consistent basis is usually considered income subject to employment tax regardless of what it is called.