IRS Revenue Ruling
2002-35

 Code Sec. 62

<<FULL TEXT>>

(Also sections 3121(a), 3306(b), 3401(a), 7805(b).)
26 CFR 1.62-2: Reimbursements and other expense allowance arrangements.
(Also sections 31.3121(a), 31.3306(b), 31.3401(a), 301.7805-1.)

Wages subject to federal employment tax. This ruling clarifies that
payments to employees for equipment they are required to provide as a
condition of employment are wages for federal employment tax purposes,
unless paid under an accountable plan.


REV. RUL. 2002-35

ISSUE

Whether amounts paid to employees for employee-provided equipment,
including vehicles, that are used by the employee to provide services as
an employee are wages subject to federal employment taxes?


FACTS

Situation 1 -- Business A is engaged in pipeline construction and
repair. A hires welder B and heavy equipment mechanic C to perform
services as employees in connection with the construction of a pipeline.
Business A requires B to provide and maintain a welding rig for B's use in
providing welding services and requires C to provide and maintain a
mechanics rig for C's use in performing repair and maintenance services at
the work site on the employer's heavy equipment. B and C are required to
provide rigs sufficient to perform the required employee services.
(Neither employee B nor C is an independent contractor.)

A welding rig consists of a truck equipped with a welding machine and
other specialized welding equipment required to perform welding services.
B is paid an hourly wage of $X for the performance of services as an
employee. In addition, A pays B an hourly amount of $Y per hour for
providing the welding rig. This rig reimbursement is only paid for those
hours that B performs services as A's employee.

A mechanics rig consists of a heavy truck equipped with a crane,
welding machine, and various other equipment used in the repair of heavy
construction equipment. C is paid an hourly wage of $X for the performance
of services as an employee. In addition A pays C an additional $Y amount
per day for providing the mechanics rig. This rig reimbursement is only
paid for the days that C performs services as A's employee.

Business A requires B and C to each execute a document specifying that
the employee owns the rig provided and will insure and maintain the rig.
Employees B and C bear all expenses associated with the operation and
maintenance of their respective rigs. The flat dollar amount paid as rig
reimbursement is not related to the actual employee business expenses B or
C incurs while performing services as an employee of A. Business A does
not require B or C to substantiate expenses incurred related to the rig
provided. Nor does A require B or C to return any amount paid as a rig
reimbursement that exceeds the actual employee business expenses B or C
incurs in connection with providing a rig while performing services as an
employee of A.

Situation 2 -- Business A also hires laborer D to perform services as
an employee. Employee D uses D's pickup truck for transportation along the
pipeline. Employee D is paid an hourly wage of $X for the performance of
services as an employee and is also paid an additional amount of $Y per
day for providing the pickup truck. Business A does not require D to
substantiate mileage or actual employee business expenses incurred while
performing services as an employee of A. Employee D is not required to
return any of the daily amounts paid for the pickup truck if the amount
paid exceeds the employee business expenses D incurred in connection with
the pickup truck while performing services as an employee of A. (Laborer D
is not an independent contractor.)


LAW AND ANALYSIS

Section 3402(a) of the Internal Revenue Code (Code) requires employers
paying wages to deduct and withhold income tax on wages. For income tax
withholding purposes, section 3401(a) provides that the term "wages," with
certain exceptions, means all remuneration for services performed by an
employee for an employer. Under sections 3111 and 3301, Federal Insurance
Contributions Act (FICA) tax and Federal Unemployment Tax Act (FUTA) tax,
respectively, excise taxes are imposed on the employer in an amount equal
to a percentage of the wages paid by that employer. Under section 3101,
FICA tax also is imposed on the employee. Under sections 3121(a) and
3306(b), the term "wages" for FICA tax purposes and FUTA tax purposes,
respectively, means, with certain exceptions, all remuneration for
employment. Under sections 3121(b) and 3306(c), "employment" is defined as
any service, of whatever nature, performed by an employee for the person
employing him.

Consistent with this definition, section 31.3121(a)-1(c) of the
Employment Tax Regulations provides that the name by which the
remuneration for employment is designated is immaterial. Section
31.3121(a)-1(d) further provides that generally, the basis upon which
remuneration is paid to an employee is immaterial in determining whether
the remuneration constitutes wages under FICA.

No specific section of the Code or regulations excepts from wages
amounts paid to employees for providing equipment used in the performance
of services as an employee. However, amounts paid to employees for certain
employee business expenses incurred in connection with such equipment are
excluded from wages if paid under a reimbursement or other expense
allowance arrangement that meets the requirements of section 62(c).

Under section 1.62-2(c)(1) of the Income Tax Regulations, a
reimbursement or other expense allowance arrangement satisfies the
requirements of section 62(c) if it meets the requirements set forth in
paragraphs (d), (e), and (f) of section 1.62-2 (business connection,
substantiation, and return of excess). If an arrangement meets these
requirements, all amounts paid under the arrangement are treated as paid
under an accountable plan. section 1.62-2(c)(2)(i). Amounts paid under an
accountable plan are excluded from the employee's gross income, are not
required to be reported on the employee's Form W-2, and are exempt from
the withholding and payment of employment taxes. Sections 31.3121(a)-3,
31.3306(b)-2, 31.3401(a)-4, and 1.6041-3(h)(1).

If an arrangement does not satisfy one or more of these requirements,
all amounts paid under the arrangement are paid under a "nonaccountable
plan." Amounts paid under a nonaccountable plan are included in the
employee's gross income for the taxable year, must be reported to the
employee on Form W-2, and are subject to withholding and payment of
employment taxes. Sections 1.62-2(c)(5), 31.3121(a)-3(b)(2),
31.3306(b)-2(b)(2), 31.3401(a)-4(b)(2), and section 1.6041-3(h)(1).
Additionally, section 1.62-2(k) provides that if a payor's reimbursement
or other expense allowance arrangement evidences a pattern of abuse of the
rules of section 62(c) and the regulations thereunder, all payments made
under the arrangement will be treated as made under a nonaccountable plan.

Rev. Rul. 68-624, 1968-2 C.B. 424, considered what portion of the total
amount paid by a corporation for the use of a truck and the services of a
driver was allocable as wages of the driver for federal employment tax
purposes. The driver hauled stone from the corporation's quarry to its
river loading dock at a fixed amount per load. The corporation allocated
one-third of the amount paid to the employee as wages and two-thirds as
payment for the use of the truck. The ruling held that an allocation of
the amounts paid to an individual when the payment is for both personal
services and the use of equipment must be governed by the facts in each
case. If the contract of employment did not specify a reasonable division
of the total amount paid between wages and equipment, a proper allocation
could have been arrived at by reference to the prevailing wage scale in a
particular locality for similar services in operating the same class of
equipment or the fair rental value of similar equipment.

Rev. Rul. 68-624 pre-dates the Tax Reform Act of 1986 (TRA '86), Pub.
L. 99-514, and the Family Support Act of 1988, Pub. L. 100-485, which
limit the deductions of employee business expenses. Pursuant to section
132 of TRA '86, which added section 67 to the Code, employee business
expenses are allowed only as miscellaneous itemized deductions, to the
extent that the aggregate of those deductions exceeds 2 percent of
adjusted gross income. Section 62(c), which was enacted in the Family
Support Act of 1988, in part limits employee business expense
reimbursements that can be excluded from adjusted gross income to those
paid under an accountable plan. Further, Rev. Rul. 68-624 does not address
whether the truck driver was engaged in the trade or business of truck
rental in addition to the trade or business of being an employee.

An arrangement that merely allocates compensation paid to an employee
between wages and a reimbursement for business expenses will not meet the
requirements of section 62(c). For example, in Shotgun Delivery, Inc. v.
United States, 269 F.3d 969 (9th Cir. 2001), the court held that a courier
company's arrangement that paid employee drivers 40 percent of the
delivery charge rate less an hourly minimum wage payment did not meet the
business connection requirement because the drivers were reimbursed
regardless of actual mileage driven or expenses incurred. Accordingly, the
arrangement was not a valid accountable plan under section 62(c).


CONCLUSION

Under the facts specified in Situations 1 and 2, the amounts paid to
employees B, C, and D for providing equipment, including vehicles, used in
performing services for the employer as an employee are not paid under an
accountable plan. Each arrangement fails the business connection
requirement because in each situation the employer pays an amount to the
employee regardless of whether the employee incurs (or is reasonably
expected to incur) business expenses that would be deductible under
sections 161 through 198. Each arrangement fails to require the employee
to substantiate employee business expenses, as required by section
1.62-2(e). Finally, the arrangements do not require the return of excess
as required under section 1.62-2(f).


HOLDING

In Situations 1 and 2, because the amounts paid to the employee for
providing equipment, including vehicles, for use in performing services as
an employee are not paid under an accountable plan, they are wages subject
to the withholding and payment of income and employment taxes.

This ruling is not intended to provide guidance regarding the treatment
of payment for equipment, including vehicles, provided by independent
contractors.

See Rev. Proc. 2002-41, published elsewhere in this Internal Revenue
Bulletin, regarding a deemed substantiation rule for use in implementing
an accountable plan in connection with reimbursements to certain employees
for costs associated with providing welding rigs or mechanics rigs.


EFFECT ON OTHER REVENUE RULINGS

This ruling revokes Rev. Rul. 68-624.


EFFECTIVE DATE

This revenue ruling is effective for payments to employees after
October 13, 1988 (the date of enactment for section 62(c), as part of the
Family Support Act of 1988).

Under the authority of section 7805(b), a taxpayer that actually paid
amounts separate from wages for the use of employee-provided equipment
(such as described in Situation 1 and the truck described in Rev. Rul.
68-624) and reported these payments on timely issued Forms 1099 for
calendar years beginning before January 1, 2002, may continue to report
these payments on Form 1099 for periods ending on or before December 31,
2002.


DRAFTING INFORMATION

The principal author of this revenue ruling is Joe Spires of the Office
of the Division Counsel/Associate Chief Counsel (Tax Exempt and Government
Entities), IRS. However, other personnel from the IRS and Treasury
Department participated in its development. For further information
regarding this revenue ruling, call Mr. Spires at (202) 622-6040 (not a
toll-free number).

<<END RULING>>

TO CONTACT
DON FITCH CPA

Phone Don Fitch CPA Toll Free at (877)CPA-Help or (877)272-4357 or on our Direct Line at (760)674-1722.