Not All Tool Reimbursement Plans Are Created Equal


In fact many will get you in trouble. This page is dedicated to educating our readers about some of the pitfalls of many tool reimbursement plans.
The IRS has not been helpful in supporting the industry with guidance and most likely, it is due to their inherent task of collecting as much tax as possible, even when there are legitimate means in the law to rightfully avoid some taxations.

Tool reimbursement plans are good for the economy and provide a resource for adding quality and value to employers, their customers and enhancing employee benefit packages.

There is no argument from the IRS that a tool reimbursement plan can be done properly and that it adds value to the participants, however they are very strict in their position as to the correct method of accounting and administering such a plan.
The first test of ‘business connection’ is the one that usually gets shot down, for a variety of reasons. The IRS is very strict on the accountable plan rules as it applies to their interpretation of the law. Once a plan fails this test, the IRS can easily deem the payments as re-characterization of wages and assessments begin.

Whether you choose to self administer using Second Check or you choose to outsource to a third party administrator, make sure the plan follows the rules of Section 62c, an accountable plan.

Here are 4 common rules that can make or break a tool reimbursement accountable plan:
  1. Tool Reimbursement payments cannot go on forever. There is no deemed substantiation1 rate, so don’t be fooled by secret formulas that claim to have figured out how to make this method work.
  2. You cannot pay for expenses that were incurred prior to current employment. It doesn’t matter how this is presented, if the expenses are not related to your business, then they do not meet compliance.
  3. You cannot pay for expenses that were incurred prior to the current tax year. Only current tax year expenses are acceptable under the IRS position2 -certain safe harbor rules apply.
  4. Substantiation is a requirement. Proof of purchase documents are required for every dollar paid out to the employee as a reimbursement.


1 Deemed substantiation is where the IRS, through their authority, will allow a flat amount or percentage to be used instead of actual substantiated costs. A good example of this method is an auto mileage reimbursement rate. The IRS allows or ‘deems’ a certain dollar amount that can be charges against the mileage traveled for business, and allows that amount to be paid as a reimbursement under an accountable plan.

2 Current tax year expenses can include current year depreciation expenses incurred against tools and equipment purchased in prior years; however the reimbursable basis cannot include the lost depreciation for past years. An example would be where an employee purchased a $700 item 2 years ago. The past 2 years depreciation is lost and cannot be included in the reimbursable basis. Only the remaining basis of $500 can be reimbursed. (The depreciation schedules for this type of equipment is 7 years)

The author is not a tax attorney or a certified public accountant and the content of this page should not be taken as authority or tax advice. Please consult your taxadvisor.