Mixed expense reimbursements and unreturned overpayments disqualified entire accountable plan.

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 to N for expenses reimbursed and payments on his tools, it is difficult, if not impossible, to determine which payments covered which debts. Additionally, N denied any overpayments were made because of alleged reimbursable expenses, but the court found his own calculations showed overpayments received and not returned. Because N did not show substantiated expenses covering the entire amount he received, the court held the payments were not made under a qualified accountable plan, and treated the reimbursements as ordinary income.

The court rejected N's argument that the substantiated payments should be treated as payments under an accountable plan, and unsubstantiated ones should be treated as payments under a nonaccountable plan. According to the court, this would effectively eliminate the third prong of the accountable-plan test and allow all substantiated expenses to be deducted from a calculation of AGI. Thus, because the plan as a whole did not meet the requirements of an accountable plan, all of the payments received were treated as ordinary income.

Tools

Finally, the court treated the tools as long-term capital assets subject to capital gain tax under Secs. 1221(a)(2) and 1222 (3), because N presented n o proof of the cost of the tools and failed to establish any basis in the assets; see Reinke, 46 F3d 760 (8th Cir. 1995) (holding the rule of Cohan, 39 F2d 540 (2d Cir. 1930) is inapplicable when the taxpayer presents "no evidence at all that would permit an informed estimate" of the claimed deduction, basis or other tax advantage). Thus, it held the tools have a zero cash basis, and the entire amount received for them should be treated as capital gain income.

STEVEN J. NAMYST, 8TH CIR. (1/27/06)