New Ruling Provides Opportunity for Dealership Tool Plans

Service technicians working for dealerships have long been required to provide, at their own cost, many of the tools they use to service vehicles. Typically, the technicians are paid an hourly wage and receive no reimbursement for the cost of these tools. Dealers interested in adding a tax-advantaged benefit or in need of attracting new technicians may wish to consider viable tool plan opportunities.

Accountable Plan Requirements
Reimbursements may be tax-free to the technician and not subject to payroll taxes if made under an accountable plan. The requirements for an accountable plan include:

Business connection. Only certain specified expenses qualify, and they must be paid or incurred by the employee in connection with performing services. If the employer pays an employee regardless of whether the employee incurs the expense, the plan does not qualify.
Substantiation. Each business expense must be substantiated to determine the specific nature of each expense and to conclude that the expense is attributable to the employer’s business activities.
Return of excess. Employees are required to return any excess amount paid under the arrangement.

One overriding issue that concerns the U.S. Internal Revenue Service (IRS) is the recharacterization of wages, such as in the following situation: An automobile dealership changes the pay structure for a service technician who is paid $20 per hour to a plan under which the technician is paid $15 per hour as wages and a tool allowance of $5 per hour. When the reimbursement equals the total expenses incurred by the employee, the employee’s wages return to $20 per hour. The IRS has reasoned that, since the technician will receive $20 per hour regardless of the amount of expenses being reimbursed, the dealership has recharacterized the service technician’s wages.

Recent Private Letter Ruling
Previous IRS guidance and rulings were unfavorable for tool plans. However, the IRS has published a private letter ruling that approves one taxpayer’s tool plan. It appears that the plan was carefully designed to overcome previous objections.

Although not a dealership, the taxpayer in the new ruling was in a similar business. This taxpayer’s plan addresses the accountable plan requirements:

Business connection. Only tools purchased while the technician is employed by the taxpayer during the current plan year and while enrolled in the plan qualify for reimbursement. The tools must be necessary for the taxpayer’s industry, used only for the taxpayer’s business, and maintained at the taxpayer’s place of business.
Substantiation. Technicians must submit a claim form that certifies the reimbursement request and meets all guidelines of the plan, along with proof-of-purchase showing the date of purchase and detail of the purchased tools. Technicians must certify that they won’t seek additional reimbursement from other sources or claim the expense as a deduction on their tax return.
Return of excess. The plan allows reimbursement only for actual expenses incurred, so there should be no excess. Any erroneous reimbursements must be returned.
Recharacterization. The plan has an annual expense limit and is a benefit completely separate from salary. There are no pay adjustments before or after the payment of any reimbursement or after the annual limit is reached.

Third-party-administered Tool Plans
While the plan in the private letter ruling is very detailed and specifically designed to meet the accountable plan rules, it apparently doesn’t resolve the faults often found in administered tool plans.

Some plans attempt to reimburse technicians for tools purchased outside the plan year or before employment. This may be deemed to violate the business connection requirement.
The administrator determines the tool reimbursement rate, sometimes using a proprietary formula. This does not clearly meet the substantiation requirement when compared to the specific accounting in the private letter ruling.
In most administered plans, the technicians’ total income does not change because the allocation of their compensation for tools is separated from the hourly rate for their service. This appears to run afoul of the recharacterization issue.

A simple plan consistent with the recent private letter ruling likely would result in little need for a third-party administrator.

Simplified Dealership Tool Plan
It appears a dealership could easily create a self-administered tool plan in keeping with the private letter ruling. Such a plan would include, at minimum:

A detailed document outlining the plan’s criteria, including an annual limit on the reimbursement and requirements for tool use and storage, timing of purchase, requirement to return erroneous overpayments, and so on;
A reimbursement form that must be submitted with a receipt or invoice; and
No change in the technicians’ pay rate and a reimbursement system that’s separate from the technicians’ current wages.

Such a plan would provide a new tax-free employee benefit, which could be useful for attracting and retaining the best technicians.

Joseph Magyar is a partner with Crowe Horwath LLP in the Tampa, Fla., office. He can be reached at 813.209.2435 or
joe.magyar@crowehorwath.com.

This article was originally published in DealersEdge.

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