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Ruling on accountable plans

 
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Ed Zollars, CPA



Joined: 25 Aug 2007
Posts: 476

PostPosted: Wed Jan 21, 2004 5:13 pm    Post subject: Ruling on accountable plans Reply with quote

The IRS issued an interesting Revenue Ruling recently that
describes both how to and how not to design an accountable
pln to absorb employee business expenses.

As we all know, expenses an employee pays personally are
only deductible to the extent they exceed 2% of adjusted
gross income and is not allowed at all for AMT purposes.
However, if the employer pays the expenses, they are not
included in the employee's income, no payroll taxes are due
and likely the employer gets a full tax deduction for the
payment. However, if an employer *reimburses* the employee
for expenses incurred, they may only be excluded if they are
reimbursed under an accountable plan that meets the
requirements of IRC Section 62(c).

An employee also cannot have the "option" of taking a
payment as salary or reimbursement--only in the area of
Section 125 plans and the various elective salary deferrals
can employees "convert" salary into nontaxable benefits "on
the fly" at their own discretion (the IRS has ruled there
are various cases where an employee, before a year begins,
may have such an option for certain other benefits, but
we'll ignore that here ).

Of course, what the employee and employer would love to be
able to do is take a portion of the employee's salary that
is paid as salary, and convert that to be treated as a
reimbursement under Section 62(c) once that reimbursed
amount is known. In that case, the employer would not have
to pay payroll taxes and the employee would avoid the
problems of employee business expenses.

Revenue Ruling 2004-1 shows both how to get awfully close to
that result--and also shows how to foul it up.

Both cases involve payments to courier employees who have
their own vehicles. In case 1, an employee is paid both a
base commission of one rate, and a mileage reimbursement
commission of another rate. The employer has set the
mileage reimbursement commission based on the employer's
recent history of actual mileage expense incurred by
couriers on jobs. The employees must report the actual
mileage back to the employer on a monthly basis, and if the
employee has been compensated in excess of the IRS mileage
allowance for his actual miles, that amount is added back to
the employee's taxable income and payroll taxes are paid.

In case 2, the employee is paid a flat rate Y. At the end
of the month, the employee again reports actual mileage to
the employer. The employer then subtracts the mileage rate
from the commissions paid, and treats that as a reimbursement.

The IRS rules that case 1 *IS* an accountable plan and that
the lessor of the reimbursement paid under the plan or the
actual mileage times the IRS rate can be excluded from the
employee's income. However, case 2 is *NOT* an accountable
plan, and all amounts must be included in income, payroll
taxes paid, and the employee has to claim the miscellaneous
itemized deduction.

The ruling can be read at:

http://www.irs.gov/pub/irs-drop/rr-04-2.pdf

Why this result? Well, the key factors appear to be that in
case 1 the employer set a maximum reimbursement ahead of
time and that rate was based on realistic and measured
expectations based on actual past results. Case 2 is a
problem because it is an attempt to reclassify something
that was paid as wages into excludable amounts *after* the fact.

This ruling is useful, though, because it tells us that a
plan *can* be designed to allow for the expected allocated
of payments to an accountable plan. It also shows that the
IRS does have limits as well, and they expect employers to
pay attention to those limits.

--
Ed Zollars, CPA
Phoenix, Arizona

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Michael T Wing CPA



Joined: 25 Aug 2007
Posts: 180

PostPosted: Thu Jan 22, 2004 12:55 pm    Post subject: Re: Ruling on accountable plans Reply with quote

Ed Zollars, CPA wrote:

> Revenue Ruling 2004-1 shows both how to get awfully close to
> that result--and also shows how to foul it up.

Would it be fair to say that this is first time that the IRS
has explicitly approved of a "plan" that did not require the
ACTUAL REFUND of amounts in excess of the "accounted"
amount?

Otherwise, this is a bit mind-numbing. I gather situation 1
could be described as follows: The employer pays a base
commission of (say) 30% of the delivery fee, plus a
guestimated mileage reimbursement of (say) 10%. The 10%
figure is based on an actual analysis of employee expense
reports during the prior year. If the employee's actual
mileage would result in a greater reimbursement using the
standard mileage allowance, that's too bad. The employee
does not receive reimbursement for such excess, but might
nevertheless be entitled to a tax deduction for such excess
amount. If, on the other hand, the actual mileage is less
than the reimbursement rate, the employer will adjust the
employee's taxable compensation accordingly. No amounts need
be refunded to the employer.

Under situation 2, the employers pays a total commission of
(say) 40%, without any specific breakdown between "services"
and "mileage." If/when the employee submits a report of
actual mileage, the employer will retroactively adjust the
taxable compensation amount to recognize an exclusion for
the mileage portion. The amount that can be reclassified is
apparently unlimited.

Does that pretty well describe it?

But, I still don't understand why situation 1 should "fly"
in the absence of an ACTUAL REFUND requirement. ???

MTW

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Ed Zollars, CPA



Joined: 25 Aug 2007
Posts: 476

PostPosted: Sun Jan 25, 2004 12:02 pm    Post subject: Re: Ruling on accountable plans Reply with quote

Michael T Wing CPA wrote:

> But, I still don't understand why situation 1 should "fly"
> in the absence of an ACTUAL REFUND requirement. ???

If push came to shove, I presume the IRS would hang its hat
on Regulation 1.62-2(c)(2)(ii) which provides:

"Special rule for failure to return excess. If an
arrangement meets the requirements of paragraphs (d), (e),
and (f) of this section, but the employee fails to return,
within a reasonable period of time, any amount in excess of
the amount of the expenses substantiated in accordance with
paragraph (e) of this section, only the amounts paid under
the arrangement that are not in excess of the substantiated
expenses are treated as paid under an accountable plan."

Now that's interesting when you look at the IRC itself on
this matter, which provides at 62(c):

"For purposes of subsection (a)(2)(A) , an arrangement
shall in no event be treated as a reimbursement or other
expense allowance arrangement if

(1) such arrangement does not require the employee to
substantiate the expenses covered by the arrangement to the
person providing the reimbursement, or

(2) such arrangement provides the employee the right
to retain any amount in excess of the substantiated expenses
covered under the arrangement. "

Now you can argue the regulation is "OK" if the employee
fails to pay back the money, even though required--the
regulation indicated what you would do if unable to get it back.

However, this ruling now expands that so that the plan can
be *designed* so that employee will fail to pay it back.

While I agree that seems to fly in the fact of the IRC
itself, the IRS has now interpreted the regulation to allow
the structure mentioned, at least for courier services.

Note that the ruling itself simply goes straight by the
issue of the employee being able to retain the excess.

Maybe you can look at this as "Frequent Flyer Miles, Part
II" .

--
Ed Zollars, CPA
Phoenix, Arizona

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Michael T Wing CPA



Joined: 25 Aug 2007
Posts: 180

PostPosted: Wed Jan 28, 2004 3:14 am    Post subject: Re: Ruling on accountable plans Reply with quote

Ed Zollars, CPA wrote:

> While I agree that seems to fly in the fact of the IRC
> itself, the IRS has now interpreted the regulation to allow
> the structure mentioned, at least for courier services.
>
> Note that the ruling itself simply goes straight by the
> issue of the employee being able to retain the excess.

I suppose I could "buy into" this ruling if the IRS was
simply attempting to develop a "de minimus" standard -
something along the lines that a "plan" will be deemed in
compliance so long as the employer's "guestimated"
reimbursement amount is computed with sufficient precision
that ~few~ retroactive adjustments are necessary and/or such
adjustments are relatively ~small~ in dollar amount.
However, I don't think that's what they had in mind.

And, yes, it will remain to be seen whether this was simply
an accommodation to a particular industry practice, or
whether it has broader application. I suspect that it could
also apply to (say) pizza delivery drivers, but somehow I
can't see it applying to fatcat corporate executives.

> Maybe you can look at this as "Frequent Flyer Miles, Part
> II" .

Well, at least in this case the beneficiaries are the SMALL
GUYS !!

MTW

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Ed Zollars, CPA



Joined: 25 Aug 2007
Posts: 476

PostPosted: Wed Jan 28, 2004 11:07 pm    Post subject: Re: Ruling on accountable plans Reply with quote

Michael T Wing CPA wrote:

> And, yes, it will remain to be seen whether this was simply
> an accommodation to a particular industry practice, or
> whether it has broader application. I suspect that it could
> also apply to (say) pizza delivery drivers, but somehow I
> can't see it applying to fatcat corporate executives.

The fact that it is a Revenue Ruling makes it a little
difficult for the IRS to ignore their logic (or lack of it
) in arriving at the conclusion that inclusion in
income is equal to the refund requirement so long as the
initial payment is reasonable by some objective standard.

--
Ed Zollars, CPA
Phoenix, Arizona

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