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Tool Plans on the IRS Hit List

June 03, 2011

The IRS has repeatedly attacked the use of tool plans as a means of avoiding taxes. The IRS recently blessed a taxpayer's reimbursement plan, but the ruling provides little practical guidance for taxpayers. The plan at issue addressed the IRS's previous concerns and followed the existing requirements exactly.

Under an acceptable tool plan, an employer may reimburse an employee for the cost of his tools tax-free, if the plan requires that (1) the tools be used for the employer's business and be deductible as a business expense, (2) the employee maintains adequate substantiation of the expense and (3) any excess reimbursements be returned to the employer.

PLR 200930029
The plan in question had the following features:

Business connection – The Tool Plan only covered expenses incurred during the current plan year and on job assignments while employed with the current employer. Tools and equipment must be maintained at the employer's place of business and must be considered necessary for the industry.

Substantiation – Employees must submit a claim form that certifies that the purchased item meets the requirements listed above and identifies the job assignments requiring the expenses. The employee must submit acceptable proof of purchase that includes the item description, date of purchase and cost within 30 days of purchase.

Repayment – The plan does not allow cash advances, so there should not be excess reimbursements. However, it states that erroneous reimbursements must be returned within 30 days.

Other – The Tool Plan required the employer to determine a maximum reimbursement limit per employee at the beginning of the year. The employer stated that reimbursements are not made as part or instead of compensation. The plan did not provide adjustments to compensation on account of reimbursements.

Although it is encouraging that the IRS did not dispute the plan above, it is hardly informative for taxpayers seeking guidance for terms not falling squarely under the rule. To use the Tool Plan as a guide would likely require employers and employees to change the terms of their current agreements.


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