Tool/Equipment Plans Meet Potential Problems at Tax Time
BY DANA NELSEN
The Internal Revenue Service stated in a release dated January 30, 2008 that many employee tool reimbursement plans offered by dealers to technicians may be in violation of tax law. A number of tool reimbursement companies that have solicited dealerships to offer this program to their employees may in actuality unknowingly be encouraging illegal activity. As the saying goes, “Ignorance of the law is no excuse.”
The IRS will be taking a close look at these programs and may be imposing steep fines to dealerships that violate the tax laws addressing tool reimbursement in 2008.
The way many of these tool plans work is the employer reduces an employee’s check by a certain amount that the tech says he will spend on tools (this amount may be spread over several of the employee’s paychecks). The tech then buys the tools needed for his job and the dealer cuts a separate tax-free reimbursement check equal to the amount the employee’s check was originally reduced by.
Tool reimbursement companies tout that the program reduces the amount of tax paid by both the employer (the social security and Medicare tax match) and the employee’s income tax. Listed on the IRS’ website it states:
Many of the tool plans currently being marketed do not meet the requirements to be tax-favored accountable plans despite their claims to the contrary. In addition to its concerns with the lack of substantiation provided by the technicians to ensure that only expenses incurred for that employer are included in the plan, the Service is focusing on the fact that the majority of the plans being marketed are designed and operated around a structure that recharacterizes a portion of the employee’s existing pay as a “reimbursement” for the employee’s tools merely to generate tax savings for both the employer and the employee. In other words, the employee continues to receive the same gross pay but what was previously paid as taxable compensation is recharacterized as nontaxable reimbursement until the employee’s alleged tool costs have been recovered, then the employee returns to his original amount of taxable compensation.
I recently spoke with Stephan King, Certified Public Accountant of Moss Adams LLP based in Scottsdale, Ariz., about the issue. King said that while he hasn’t looked at every tool reimbursement program in the country, he has looked at a number of well-known companies offering these plans and has yet to find one that the works under the stipulations defined by the IRS.
King warns that penalties may double the amount of tax that should have been paid to the IRS and they may go back several years to see if previous violations occurred. Interest may also be due for previous year’s violations.
While the IRS report is fairly new, the IRS’ stance on this issue has been unchanged for a number of years. In 2000, the IRS issued a paper titled “Service Technicians’ Tool Reimbursement Plans.” This document stated, “…generally, amounts paid to motor vehicle service technicians as tool reimbursements will not meet the accountable plan requirements.” While this specifically mentions “motor vehicle,” the IRS’ website further explains that this ruling applies to other vehicle industries like RVs.
My question for dealers this week is, how many have implemented or considered implementing a program similar to this for their employees? Are there other programs to help get technicians the tools they need that do not violate what the IRS will be scrutinizing this year? As usual your thoughts are welcome.
Thanks for reading.
April 3rd, 2008 at 11:16 pm
Obviously, anyone who has knowledge of employee tax law would know the programs mentioned by the IRS would be illegal. However, I wonder if the following program example might help both the dealer and technician and still follow the spirit of the law.
A dealer can expense a certain amount of equipment each year before tax - Let’s use $20,000 as an example. The dealer purchases the tools and expenses them on the current years income taxes. Now, the dealer allows the technicians to use the tools for a certain period of time and then sells the tools to the technician at a discounted price - The original tool cost less the tax savings. The dealer then pays tax on the recovered amount the tools were sold for.
Now I’m no CPA (just three years of college accounting and 42-years of running a business) but I think within certain parameters, the above example could be made to work and be a benefit to both the dealer and the employee technician.
March 26th, 2008 at 1:20 pm
So let me get this straight, the employer withholds $X each week from the employee to put in a “tool savings” account. This money is not taxed with the rest of the employees paycheck, it is removed before taxes are calculated. Then, when the employee is ready to buy his tools, the employer writes the employee a check, without taking taxes out, for the full amount. Is this correct? So, the employee is not paying taxes on his earnings, and the employer is not paying his taxes on this money either. I can see where that is not kosher with the IRS. To my knowlege the only way to have money with held from your check without paying taxes on it is to buy overpriced health insurance, or put it in a 401K. If anyone knows any different, please let me know!!!
March 25th, 2008 at 4:23 pm
Thanks for the good article, Dana. While we are not involved in this type of activity, I am familiar with other organizations that sponsor this type of plan for their employees. One such firm that participates has an active apprentice-employee plan in which the Employer withholds an employee-authorized percentage of the employee’s wages in a “Tool Savings Account”. The apprentice-employee can then purchase tools (at a company sponsored discounted price) to stock his/hers toolkit.
I have not heard that this program is in violation of the IRS policy. However, I would guess that it is not in violation.
However, Dana, I also feel that the IRS may have a case in the Employer-Employee plan as you outlined.
Gene