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IRS clarifies which reimbursements are taxable as wages
An arrangement that recharacterizes taxable wages as nontaxable reimbursements does not satisfy the business connection requirement to be considered an accountable expense reimbursement plan, according to a new clarification by the IRS.
These reimbursements are treated as made under a non-accountable plan and are taxable income to the employee.
Reimbursements are tax-free to an employee and are not subject to withholding or payroll taxes if made under an accountable plan. An accountable reimbursement plan must meet all of the following requirements:
The reimbursed expense must be allowable as a deduction and must be paid or incurred in connection with performing services as an employee of the employer.
Each reimbursed expense must be adequately accounted for to the employer within a reasonable period of time.
Reimbursements in excess of actual expenses must be returned within a reasonable period of time.
“Wage recharacterization” is taxable because the amount being paid is not an expense reimbursement but rather a substitute for an amount that would otherwise be paid as wages, according to Revenue Ruling 2012-25. Wage recharacterization occurs when an employer does any of the following:
Temporarily reduces taxable wages, substituting the reduction in wages with a payment that is treated as a nontaxable reimbursement and then, after total expenses have been reimbursed, increases taxable wages to the prior wage level.
Pays a higher amount as wages to an employee only when he does not receive an amount treated as a nontaxable reimbursement and pays a lower amount as wages to an employee only when he also receives an amount treated as nontaxable reimbursement.
Routinely pays an amount treated as a nontaxable reimbursement to an employee who has not incurred bona fide business expenses.
The technical information here is necessarily brief. No final conclusion on these topics should be drawn without further review and consultation. Please be advised that, based on current IRS rules and standards, the information contained herein is not intended to be used, nor can it be used, for the avoidance of any tax penalty assessed by the IRS.
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