Tool plans that claimed to pay employer reimbursements or rental fees to employees who used their own tools in their jobs were abusive tax schemes. The Tax Court imposed civil penalties on two executives of CMS, the company that developed the arrangements and falsely marketed them as accountable plans to reimburse employee expenses.
Why Mischaracterize the Arrangements as Accountable Plans?
- Are excluded from the employee’s income,
- Are not reported as wages or compensation,
- Are not subject to withholding, and
- Are not subject to employment taxes.
However, reimbursements paid under a nonaccountable plan are treated just the opposite. Thus, they are included in the employee’s gross income, they must be reported as wages or compensation on the employee’s Form W-2, and they are subject to withholding of income and employment taxes.
So treating reimbursements as paid under an accountable plan offers real tax benefits to both employers and employees—especially if those “reimbursements” simply disguise what would otherwise be taxable wages.
What is an Accountable Plan?
An accountable plan must include these three requirements:
- The plan must require payments to have a business connection – that is, advances and reimbursements must be for costs that the employee could treat as business expenses.
- The plan must require employee to substantiate the reimbursed expenses to the employer.
- The plan must require employees to return excess reimbursements to the employer.
CMS Tool Program Mischaracterized Wages as Reimbursements, Rentals
The CMS Tool Program purportedly helped an employer pay reimbursements and rental fees to employees who used their own tools on the job. In reality, however, the Program just took a set portion of the employee’s taxable wages and recharacterized it as nontaxable reimbursements paid under an accountable plan.
The CMS plans failed all three of the accountable plan tests:
- The plans did not require employees to show that they used their own tools in the employer’s business.
- The plans allowed employees to estimate the cost of their tools without substantiating any actual expenses.
- Finally, the plans did not require the return of any excess reimbursements.
Penalties Imposed on CMS Executives
Two CMS executives who developed and marketed the tool plans were penalized for promoting an abusive tax arrangement. When they marketed the Tool Program, the executives made material statements that they knew or had reason to know were false.
In particular, the executives continued to market the various phases of the Program as accountable plans even after several independent tax firms advised them the plans were not accountable. The executives also exaggerated the tax benefits of the plans, underplayed their audit risks, and misrepresented applicable tax law.
IRS Actions to Limit Tool Plans
The IRS began tightening up the accountable plan requirements for tool plans in 2002, a few years after CMS began offering its Tool Program. The IRS provided detailed accountable plan rules first in guidance aimed at the pipeline construction industry, and later in guidance for tool plans in general. In fact, one of the tax advisors consulted by CMS pointed out that the CMS Tool Program was virtually indistinguishable from the tool plan the IRS rejected in this guidance.
The IRS began auditing 24 CMS clients in 2008. All were found liable for additional employment taxes, totaling almost $4.6 million.
In 2010, the IRS obtained an injunction against the two CMS executives that ordered them to stop developing or marketing any tax plans. As a result of the injunction, the executives’ CPA licenses were suspended. The executives were also indefinitely suspended from representing anyone in front of the IRS. Finally, the IRS imposed the tax shelter promotion penalty on both executives for 2009 and 2010, and the Tax Court agreed the penalties were proper.
Kelley Wolf, J.D., LL.M.