IRS OFFERS A PREVIEW OF COMING REGS ON REIMBURSEMENT ARRANGEMENTS.

Announcement 90-127

This announcement clarifies certain rules under section 62(c) of the Internal Revenue Code regarding reimbursement and other expense allowance arrangements. The Internal Revenue Service expects to issue final regulations in the near future which will incorporate the clarifications discussed in this announcement.

BACKGROUND.

On December 12, 1989, the Federal Register published (54 F.R. 51021) temporary regulations on employee business expense reimbursements and allowances (section 1.62-2T of the temporary Income Tax Regulations). Section 1.62-2T(c)(2) provides that amounts paid to an employee under a reimbursement or other expense allowance arrangement that meets all the requirements in the regulations (business connection, substantiation to the employer, and return of excess) are treated as paid under an "accountable plan." Amounts paid under an accountable plan are excluded from the employee's gross income, are not reported as wages or other compensation on the employee's Form W-2, and are exempt from the withholding and payment of employment taxes under section 1.62-2T(c)(4).

However, section 1.62-2T(c)(3) of the regulations provides that amounts paid under an arrangement that fails one or more of the requirements in the regulations are treated as paid under a "nonaccountable plan." Amounts paid under a nonaccountable plan are includible in the employee's gross income, are required to be reported as wages or other compensation on the employee's Form W-2, and are subject to the withholding and payment of employment taxes under section 1.62-2T(c)(5).

On December 26, 1989, the Service published Rev. Proc. 89-66, 1989-2 C.B. 792, and Rev. Proc. 89-67, 1989-2 C.B. 795. Rev. Proc. 89-66, as amplified and modified by Rev. Proc. 90-34, 1990-1 C.B. 552, sets forth the standard mileage rates for 1990 and provides the deemed substantiation rules for the amount of automobile business expenses covered by a mileage allowance. Rev. Proc. 89-67, as amplified, modified, and clarified by Rev. Proc. 90-15, 1990-1 C.B. 476, and Rev. Proc. 90-38, 1990-28 I.R.B. 13, provides the deemed substantiation rules for the amount of travel expenses covered by a per diem allowance.

ACCOUNTABLE PLAN AND NONACCOUNTABLE PLAN PAYMENTS UNDER AN EXPENSE ALLOWANCE ARRANGEMENT.

Section 1.62-2T(c)(1) of the regulations provides that a payor may have more than one reimbursement or other expense allowance arrangement with respect to a particular employee, depending on the facts and circumstances. If a payor has an arrangement that would in part be an accountable plan and in part be a nonaccountable plan if both parts were viewed separately, the arrangement will be treated as two expense allowance arrangements -- one, a fully accountable plan, and the other, a fully nonaccountable plan. The payor must, however, treat as wages or other compensation the payments made to the employee under the nonaccountable plan portion of the arrangement (i.e., report the payments as wages or other compensation on the employee's Form W-2 and withhold and pay employment taxes on the payments). See, section 1.6041-2 of the Income Tax Regulations and sections 31.3121(a)-2T, 31.3231(e)-3T, 31.3306(b)-2T, and 31.3401(a)- 2T of the Employment Tax Regulations.

For example, assume that a payor in the transportation industry pays per diem allowances to its employees for meal and incidental expenses (1) for travel away from home that requires sleep or rest ("overnight payments"), and (2) for travel that does not require sleep or rest ("nonovernight payments"). Assume further that the payor requires its employees to substantiate the time, place, and business purpose of the expenses and reimburses them at a rate that does not exceed the applicable Federal meal and incidental expense rate. Viewed separately, the portion of the arrangement providing the overnight payments meets the requirements of section 1.62-2T(c)(2) of the regulations and, thus, will be treated as paid under an accountable plan. Viewed separately, the portion of the arrangement providing the nonovernight payments does not meet the business connection requirement of section 1.62-2T(d) and, therefore, will be treated as paid under a nonaccountable plan. Accordingly, the payor must treat the nonovernight payments as wages or other compensation (i.e., report the payments as wages or other compensation on the employee's Form W-2 and withhold and pay employment taxes on the payments).

REIMBURSEMENTS AT A RATE EXCEEDING THE APPLICABLE STANDARD MILEAGE RATE OR FEDERAL PER DIEM RATE.

Section 1.62-2T(e) and (f) of the regulations provides that an arrangement must require that business expenses be substantiated within a reasonable period of time and that amounts paid in excess of the expenses substantiated be returned within a reasonable period of time. Section 1.62-2T(h) provides that if the reasonable period requirements are not met, the amount that is treated as paid under a nonaccountable plan is subject to withholding and payment of employment taxes no later than the first payroll period following the end of the reasonable period.

If, under an accountable plan, a payor pays a mileage allowance or pays a per diem allowance in lieu of reimbursing actual expenses and does not require the employee to return the portion of the allowance that exceeds the amount deemed substantiated, the excess portion is treated as paid under a nonaccountable plan. Section 1.62- 2T(c)(3)(ii) and (c)(5). In other words, if a payor pays a mileage allowance at a rate that exceeds the applicable standard mileage rate (26 cents per mile for 1990 for business travel) or pays a per diem allowance at a rate that exceeds the applicable Federal per diem rate, the portion of the amount paid in excess of the applicable standard mileage rate or the applicable Federal per diem rate is treated as paid under a nonaccountable plan and is subject to withholding and payment of employment taxes.

Because the employee is not required to return the excess portion, the reasonable period of time provisions of section 1.62- 2T(f) of the regulations, relating to the return of excess amounts, do not apply to the excess portion. Thus, in the case of a reimbursement, the excess portion is subject to withholding and payment of employment taxes in the payroll period in which the payor reimburses expenses substantiated by the employee. In the case of an advance, the excess portion is subject to withholding and payment of employment taxes no later than the first payroll period following the payroll period in which the expenses with respect to which the advance was paid are substantiated. Of course, if the expenses with respect to which the advance was paid are not substantiated within a reasonable period of time, the payor must withhold and pay employment taxes on the entire advance no later than the first payroll period following the end of the reasonable period.

For example, assume that an employer pays its employees a mileage allowance at a rate of 30 cents per mile (when the business standard mileage rate is 26 cents per mile) to cover automobile business expenses. The employer does not require the return of the portion of the mileage allowance (4 cents) that exceeds the business standard mileage rate. In June, the employer advances an employee $150 for 500 miles to be traveled by the employee during the month. In July, the employee substantiates to the employer 500 business miles traveled. The amount deemed substantiated by the employee is $130 and the employee is not required to return the remaining $20 of the advance. No later than the first payroll period following the payroll period in which the business miles traveled are substantiated, the payor must withhold and pay employment taxes on $20.00 (500 miles x 4 cents per mile).

As another example, assume that a payor pays an employee a per diem allowance to cover business expenses for meals and lodging for travel away from home at a rate of 120 percent of the Federal per diem rate for the localities to which the employee travels. The employer does not require the employee to return the 20 percent by which the reimbursement for those expenses exceeds the applicable Federal per diem rate. The employee substantiates six days of travel away from home: 2 days in a locality in which the Federal per diem rate is $100 and 4 days in a locality in which the Federal per diem rate is $125. The employer reimburses the employee $840 for the 6 days of travel away from home (2 x (120% x $100) + 4 x (120% x $125)), and does not require the employee to return the excess payment of $140 ((2 days x $20 ($120 - $100) + 4 days x $25 ($150 - $125)). For the payroll period in which the employer reimburses the expenses, the employer must withhold and pay employment taxes on $140.

OBLIGATION TO WITHHOLD AND PAY EMPLOYMENT TAXES ON NONACCOUNTABLE PLAN PAYMENTS BEGAN ON JULY 1, 1990.

The Service reminds payors of payments under a reimbursement or other expense allowance arrangement that the obligation to withhold and pay employment taxes on amounts paid under a nonaccountable plan (including certain amounts that do not meet the requirements of a FAVR allowance as set forth in Rev. Proc. 90-34) became effective for payments received by employees on or after July 1, 1990, with respect to expenses paid or incurred on or after July 1, 1990. See sections 31.3121(a)-2T, 31.3231(e)-3T, 31.3306(b)-2T, and 31.3401(a)-2T of the Employment Tax Regulations.

ANTI-ABUSE PROVISION.

If it is determined upon examination of a payor's reimbursement or other expense allowance arrangement that there is a pattern of abuse of the rules under section 62(c) of the Code regarding reimbursement and other expense allowance arrangements, the Service will treat all payments made under the arrangement as made under a nonaccountable plan and will also impose the appropriate penalties.

DRAFTING INFORMATION

The principal author of this announcement is Beverly A. Baughman of the Office of Assistant Chief Counsel (Income Tax and Accounting). For further information regarding this announcement, contact Ms. Baughman on (202) 566-5985 (not a toll-free call).