In January, they assembled a team to tackle their long-time concerns about vendors widely marketing faulty plans to dealerships and other companies that employ service technicians who provide their own tools.

Regardless of vendor claims, in many cases, employees and employers are inaccurately re-characterizing a portion of employee pay to generate tax savings for both parties.

This action clearly does not meet the requirements of tax-favored accountable plans under the Internal Revenue Code 62(c) and the accompanying regulations.

How do I know if my tool plan is accountable?
Three requirements must be met for a tool plan to be considered accountable by the IRS:

• Business connection (must be related to performance of services as an employee)
• Substantiation (must be a specific accounting of expenses)
• Returning amounts in excess of substantiated expenses (reimbursements in excess of actual costs)

If the requirements above are not met, the plan is considered nonaccountable. The IRS’s renewed effort is intended to identify nonaccountable plans and determine if businesses are following tax rules correctly.

Accountable vs. nonaccountable tool plans
The chart below outlines the differences between accountable and nonaccountable tool plans:

Accountable plans (tax-favored)	Reimbursements not reported as wages on W-2	Reimbursements exempt from withholding and payment of payroll taxes	Tool reimbursement requirements are met, and amounts paid are not taxed
Nonaccountable plans (many marketed tool plans fall into this category, though vendors may say otherwise)	Reimbursements must be reported as wages on W-2	Reimbursements not exempt from withholding and payment of payroll taxes	Tool reimbursement requirements are not met, and amounts paid must be reported and taxed

In other words, in a nonaccountable plan guised as accountable, the employee continues to receive the same gross pay, but the amount that was previously paid as taxable compensation is re-characterized as nontaxable reimbursement until the employee’s alleged tool costs have been recovered. The employee then returns to the original amount of taxable compensation.

Consequences of noncompliance
If the IRS determines a plan does not qualify for accountable plan treatment, the amounts paid under the arrangement will be subject to withholding, and employment taxes and penalties will be assessed to the employer. The IRS adjustments will be expensive due to the compounding late deposit penalties on delinquent payroll taxes.

Next steps
By fall 2008, the IRS is expected to communicate their plan to re-address the misuse of tool plans. They are in the process of investigating vendors marketing these plans and how their clients are using them. Names will likely be taken from vendor client lists.

In addition, they are revising the Coordinated Issue Paper, Service Technicians' Tool Reimbursements, which concluded that “generally, amounts paid to motor vehicle service technicians as tool reimbursements will not meet the accountable plan requirements.”