New IRS Ruling on Accountable Plans and Wage Recharacterization

On September 10, 2012, the IRS issued Revenue Ruling 2012-25 regarding the circumstances under which payments to employees can be treated as tax-free expense reimbursements under the “accountable plan” rules.  While the ruling does not appear to represent a significant departure from earlier IRS pronouncements, it does provide a thorough reiteration and summary of the “accountable plan” rules, especially of the “wage recharacterization” component of the rules.


Under Section 1.62-2(c) of the Income Tax Regulations, payments under a reimbursement or other expense allowance arrangement are treated as made under an “accountable plan”, and therefore are exempt from income and employment taxes, if they meet all three of the following tests:

  • The reimbursement is for expenses incurred in the employer’s business. This is known as the “business connection” requirement.
  • The employee substantiates the expenses.
  • The employee returns to the employer any amounts not spent on business-related expenses.

Section 1.62-2(d)(3)(i) provides that the business connection requirement is not satisfied if a payor pays an amount to an employee regardless of whether the employee incurs or is reasonably expected to incur deductible business expenses. The regulation refers to this as “wage recharacterization.”


Revenue Ruling 2012-25 states that, generally, “wage recharacterization is present when the employer structures compensation so that the employee receives the same or a substantially similar amount whether or not the employee has incurred deductible business expenses related to the employer’s business.”  The ruling explains that taxable wages would be present in each of the following three scenarios.

  1. A cable television company provides its technicians with an hourly payment for tools.  The technician can keep the payment regardless of whether the technician actually incurs expenses for tools.
  2. A nursing staffing contractor pays the same amount to its nurses who travel away from their homes as it does to its nurses who work within commuting distance of their homes, but, in the case of the nurses who travel away from home, it recharacterizes a portion of the payments as travel expense reimbursements.
  3. A construction company pays a flat “mileage reimbursement” to its employees, regardless of whether they use their personal vehicles for travel on behalf of the company.

The ruling contrasts these outcomes with the result in a fourth scenario in which a cleaning services company reimbursed its employees for cleaning supplies and equipment, but only if they actually incurred such expenses and substantiated them to the employer.  In this situation, the IRS ruled that the business connection requirement was satisfied and that the reimbursements could be provided on a tax-free basis.

E. Drew Cheney Posted By
E. Drew Cheney