Mixed expense reimbursements and unreturned overpayments disqualified entire accountable plan.

• Author: Namyst, Steven J.

When monthly expense reimbursement checks did not differentiate between substantiated expenses, overpayments and payments for tools, and excess amounts were not returned, the entire reimbursement was included in the employee's income.

Facts

When N began employment as an engineer for IMC, IMC paid him wages reported on Form W-2. When IMC could no longer afford to pay N's salary, N offered to work without salary, provided IMC would reimburse him for expenses. IMC did not treat these payments as wages, and did not report them on Form W-2.

N submitted receipts for expenses to IMC and it issued checks to N from the corporate checking account when it had available funds--roughly one check per month, ranging from $500 to $4,000. N's payments were almost always issued in round numbers. N kept receipts and recorded amounts owed on a spreadsheet.

N sold IMC his own tools at an agreed-on price; however, he could not produce any evidence of the actual cost basis. IMC claimed it paid for the tools in installments when funds were available, but the payments did not differentiate between reimbursements and payments for the tools.

Analysis

Sec. 62 exempts from adjusted gross income (AGI) payments received from an accountable plan between employers and employees under Regs. Sec. 1.62-2. To be accountable, the taxpayer must show: (1) a business connection (i.e., the reimbursements are only for business expenses that are allowable as deductions); (2) all expenses were substantiated by the employee; and (3) the employee was required to return to the employer all amounts in excess of the substantiated expenses; see Regs. Sec. 1.62-2(d), (e) and (f); see also Biehl, 118 TC 467 (2002), aff'd, 351 F3d 982 (9th Cir. 2003). If the money received by the employee constituted an advance, the "amount of money advanced [must be] reasonably calculated not to exceed the amount of anticipated expenditures," and the employee must return any excess amounts advanced within a reasonable time, under Sec. 1.62-2(f)(1). In this case, the first two elements are not contested, the only issue is whether N returned money received in excess of his substantiated expenses.

Return of Excess

IMC paid N by check in whole dollar amounts. The court found no evidence that showed whether the payments to N correlated with the expenses submitted by him. Because IMC did not differentiate between payments...