Wage recharacterization. This ruling provides guidance for employers under section 62(c) of the Code and the applicable regulations. The ruling clarifies that an arrangement that recharacterizes taxable wages as nontaxable reimbursements or allowances does not satisfy the business connection requirement of the accountable plan rules under section 62(c) and the applicable regulations. Specifically, this ruling includes four situations. Three of the situations illustrate arrangements that impermissibly recharacterize wages, such that the arrangements are not accountable plans. The fourth situation illustrates an arrangement that does not impermissibly recharacterize wages, where an employer prospectively alters its compensation structure to include a reimbursement arrangement.

This procedure provides instructions and information on the Internal Revenue Service's letter-forwarding program. Rev. Proc. 94-22 modified and superseded.

Whether an arrangement that recharacterizes taxable wages as nontaxable reimbursements or allowances satisfies the business connection requirement of the accountable plan rules under § 62(c) and the applicable regulations.

Section 61 of the Internal Revenue Code (Code) defines gross income as all income from whatever source derived. Section 62(a) defines adjusted gross income as gross income minus certain deductions. Section 62(a)(2)(A) provides that, for purposes of determining adjusted gross income, an employee may deduct certain business expenses paid by the employee in connection with the performance of services as an employee of the employer under a reimbursement or other expense allowance arrangement. Section 62(c) provides that, for purposes of § 62(a)(2)(A), an arrangement will not be treated as a reimbursement or other expense allowance arrangement if (1) the arrangement does not require the employee to substantiate the expenses covered by the arrangement to the person providing the reimbursement, or (2) the arrangement provides the employee the right to retain any amount in excess of the substantiated expenses covered under the arrangement.

Under section 1.62-2(c) of the Income Tax Regulations, if a reimbursement or other expense allowance arrangement meets the requirements of business connection, substantiation, and returning amounts in excess of substantiated expenses, all amounts paid under the arrangement are treated as paid under an accountable plan. Amounts treated as paid under an accountable plan are excluded from an employee’s gross income, are exempt from withholding and payment of employment taxes, and are not reported as wages on the employee’s Form W-2. If the arrangement fails any one of these requirements, amounts paid under the arrangement are treated as paid under a nonaccountable plan, must be included in the employee’s gross income for the taxable year, are subject to withholding and payment of employment taxes, and must be reported as wages or other compensation on the employee’s Form W-2.

Section 1.62-2(d)(1) provides that an arrangement satisfies the business connection requirement if it provides advances, allowances, or reimbursements only for business expenses that are allowable as deductions by part VI, subchapter B, chapter 1 of the Code, and that are paid or incurred by the employee in connection with the performance of services as an employee of the employer. Thus, not only must an employee actually pay or incur a deductible business expense, but the expense must arise in connection with the employment for that employer.

Section 1.62-2(d)(3)(i) provides that the business connection requirement will not be 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. Failure to meet this reimbursement requirement of business connection is referred to as wage recharacterization because the amount being paid is not an expense reimbursement but rather a substitute for an amount that would otherwise be paid as wages.

Section 1.62-2(j) Example 1 provides an illustration of a case in which the reimbursement requirement is not satisfied. In this example, Employer S pays its engineers $200 a day. On those days that an engineer travels away from home on business for Employer S, Employer S designates $50 of the $200 as paid to reimburse the engineer’s travel expenses. On all other days, the engineer receives the full $200 as taxable wages. Because Employer S would pay an engineer $200 a day regardless of whether the engineer was traveling away from home, the $50 Employer S redesignates as travel expense reimbursement on days the engineer is away from home on business is not a reimbursement and the arrangement does not satisfy the reimbursement requirement of § 1.62-2(d)(3)(i). Thus, no part of the $50 Employer S designated as a reimbursement is treated as paid under an accountable plan. Rather, all payments under the arrangement are treated as paid under a nonaccountable plan. Employer S must report the entire $200 as wages or other compensation on the employees’ Forms W-2, and must withhold and pay employment taxes on the entire $200 when paid.

Section 1.62-2(j) Example 3 also illustrates a failure to satisfy the reimbursement requirement. In this example, Corporation R pays all its salespersons a salary. Corporation R also pays a travel allowance under an arrangement that otherwise meets the requirements of business connection, substantiation, and returning amounts in excess of substantiated expenses. The allowance is paid to all salespersons, including salespersons that Corporation R knows, or has reason to know, do not travel away from their offices on Corporation R business and would not be reasonably expected to incur travel expenses. Because the allowance is not paid only to those employees who incur (or are reasonably expected to incur) expenses of the type described in § 1.62-2(d)(1) or (d)(2), the arrangement does not satisfy the reimbursement requirement of § 1.62-2(d)(3)(i). Thus, no part of the allowance Corporation R designated as a reimbursement is treated as paid under an accountable plan. Rather, all payments under the arrangement are treated as paid under a nonaccountable plan. Corporation R must report all payments under the arrangement as wages or other compensation on the employees’ Forms W-2 and must withhold and pay employment taxes on the payments when paid.

In Rev. Rul. 2004-1, 2004-1 C.B. 325, drivers of a courier company were paid a mileage allowance for local transportation expenses. In situation 1 of the ruling, the employer paid the couriers a commission equal to X percent of the per package charge (based on location, time of day, type of service, mileage between pickup and delivery, and other factors), known as the tag rate, and a mileage allowance equal to Y percent of the tag rate. In situation 2, the employer paid the couriers a commission equal to Z percent of the tag rate reduced by a mileage allowance equal to the number of miles traveled multiplied by the standard mileage rate. The revenue ruling concludes that the reimbursement arrangement in situation 1, which pays a mileage allowance as a fixed percentage of the tag rate, meets the business connection requirement. In contrast, the revenue ruling concludes that the reimbursement arrangement in situation 2, which subtracts a mileage allowance (calculated at the standard business mileage rate) from the driver’s set commission rate and treats only the remaining commission as wages, fails the business connection requirement. The variable allocation between commission and mileage allowance in situation 2 ensures that each driver always receives the same gross amount regardless of the amount of deductible employee business expenses incurred by the courier by varying the amount treated as wages in light of the mileage allowance paid. Accordingly, the arrangement effectively recharacterizes amounts otherwise payable as a taxable commission as a non-taxable mileage allowance. The ruling provides that a bona fide reimbursement arrangement must preclude the recharacterization as a mileage allowance of amounts otherwise payable as commission. See Shotgun Delivery v. United States, 269 F.3d 969 (9th Cir. 2001) (holding that a plan guaranteeing that employee drivers always received 40% of the tag rate with a variable allocation between taxable wages and nontaxable mileage reimbursement was nonaccountable, and noting that “the evidence suggests that the plan’s primary purpose was to treat the least amount possible of the driver’s commission as taxable wages”).

The legislative history of § 62(c) indicates that a taxpayer should not be able to recharacterize an amount that would have been paid as wages as a nontaxable reimbursement in order to avoid the two-percent of adjusted gross income limitation (two-percent floor), enacted by the Tax Reform Act of 1986, for deducting most employee business expenses. Specifically, the Tax Reform Act of 1986 significantly changed rules for deduction of employee business expenses by converting most of these expenses into itemized deductions that an employee could only deduct if the aggregate of such expenses exceeded the two-percent floor. However, the 1986 Act left in place the ability of a taxpayer to deduct from gross income and without regard to the two-percent floor, pursuant to § 62(a)(2)(A), employee business expenses incurred by a taxpayer as part of a reimbursement or other expense allowance arrangement with his or her employer. After enactment of the 1986 Act, tax practitioners proposed that employers could use reimbursement and expense allowance arrangements to (1) eliminate the effect of the two-percent floor on deductible employee expenses, and (2) save both employer and employee employment taxes by restructuring their compensation packages to convert a portion of an employee’s compensation into a nontaxable reimbursement. This restructuring would permit employers to pay a lesser total amount while increasing employees’ after-tax compensation.

Congress responded by enacting § 62(c) in § 702 of the Family Support Act of 1988, 100 P.L. 485, 102 Stat. 2343 (1988). In describing the conference agreement, the House-Senate Conference Committee Report on that Act states that “[i]f an above-the-line deduction is allowed for expenses incurred pursuant to a nonaccountable plan, the two-percent floor enacted in the [Tax Reform Act of 1986] could be circumvented solely by restructuring the form of the employee’s compensation so that the salary amount is decreased, but the employee receives an equivalent nonaccountable expense allowance.” H.R. Rep. No. 100-998, at 203, 100th Cong., 2nd Sess. (Sept. 28, 1988). Section 62(c) was enacted to prevent such restructuring of compensation arrangements and permit an above-the-line deduction only for expenses reimbursed under what legislative history referred to as an accountable plan.

Consistent with legislative history, the preamble to Treasury Decision 8324, 55 FR 51688, 1991-1 C.B. 20, 21 (1990), states:

While an employer may establish or modify its compensation structure to include nontaxable reimbursement under an accountable plan, recharacterizing as nontaxable reimbursements amounts that would otherwise be paid as wages violates the business connection requirement of § 1.62-2(d), and more specifically the reimbursement requirement of § 1.62-2(d)(3)(i). This is true even if an employee actually incurs a deductible expense in connection with employment with the employer.

The presence of wage recharacterization is based on the totality of facts and circumstances. 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. Wage recharacterization may occur in different situations. For example, an employer recharacterizes wages if it temporarily reduces taxable wages, substituting the reduction in wages with a payment that is treated as a nontaxable reimbursement and then, after total expenses have been reimbursed, increases taxable wages to the prior wage level. Similarly, an employer recharacterizes wages if it pays a higher amount as wages to an employee only when the employee does not receive an amount treated as nontaxable reimbursement and pays a lower amount as wages to an employee only when the employee also receives an amount treated as nontaxable reimbursement. An employer also recharacterizes wages if it routinely pays an amount treated as a nontaxable reimbursement to an employee who has not incurred bona fide business expenses.

The principal author of this revenue ruling is Kelly Morrison-Lee of the Office of Division Counsel/Associate Chief Counsel (Tax Exempt & Government Entities). For further information regarding this revenue ruling, contact Kelly Morrison-Lee at (202) 622-0047 (not a toll-free call).

This revenue procedure modifies and supersedes Revenue Procedure 94-22, 1994-1 C.B. 608, and provides instructions and information on the Internal Revenue Service’s (Service’s) letter-forwarding program. This program is available to private individuals, as well as state and federal agencies, who are attempting to locate missing individuals.

01. This revenue procedure has been modified to remove language from the “Purpose,” “Background,” and “Scope” Sections of Revenue Procedure 94-22 that provide that the Service will forward letters on behalf of an individual, company or organization that controls assets that may be due a taxpayer, including Plan Administrators, sponsors of qualified retirement plans, or qualified termination administrators (“QTAs”) of abandoned plans under the Department of Labor’s Abandoned Plan Program who are attempting to locate missing plan participants. Since the release of this revenue procedure in 1994, several alternative missing person locator resources, including the Internet, have become available. Accordingly, the Service will no longer consider locating a missing taxpayer who may be entitled to a retirement plan payment or other financial benefit from an individual, company or organization to be a humane purpose for which the Service will provide letter-forwarding services.

02. The “Procedure” section is updated to reflect the correct address to which an individual requesting letter forwarding service must send the written request.

Under Policy Statement P-1-187, the Service established a program whereby the Service will forward a letter to a missing individual on behalf of a private individual or government agency if this action is for a humane purpose and there is no other way to relay the information to the individual. Revenue Procedure 94-22 allowed an individual, company, or organization that controls assets that may be due a taxpayer, including Plan Administrators, sponsors of qualified retirement plans, or QTAs of abandoned plans under the Department of Labor’s Abandoned Plan Program attempting to locate missing plan participants, to make a written request to the Service to use its letter forwarding program. Under this revenue procedure, the Service will no longer provide letter-forwarding services to locate a taxpayer that may be owed assets from an individual, company, or organization. The letter-forwarding program is now limited to situations in which a person is trying to locate a taxpayer to convey a message for a humane purpose as defined in Section 4 or in an emergency situation.

01. The Service will forward letters that serve a “humane purpose.” A humane purpose is one in which a person is seeking to find a missing person to convey a message of an urgent or compelling nature, or is seeking to find a missing person because of an emergency situation. For example, the Service will forward letters to notify a person of a serious illness, imminent death or the death of a close relative, to locate a missing relative to convey an urgent or compelling message, or to help locate persons being sought for a medical study to detect and treat medical defects or diseases.

02. Examples of matters that are not considered to be for a humane purpose include tracing a family tree or attempting to locate individuals for reunion purposes. Likewise, the Service will not forward letters seeking reparation and will not forward letters from individuals, companies or organizations that control assets that may be due taxpayers, including Plan Administrators, sponsors of qualified retirement plans, or QTAs of abandoned plans under the Department of Labor’s Abandoned Plan Program attempting to locate missing plan participants. Letter-forwarding requests that do not serve a humane purpose, such as requests that merely provide a financial benefit, will not be processed.

03. The Service will perform this letter-forwarding service only if the Service determines that it will not interrupt other Service activities or conflict with prior Service commitments. Under no circumstances will the Service disclose to the requester confidential tax information, such as an address or even the fact that an address exists in Service files.

01. The requester must submit a written request that briefly explains the requester’s need for letter-forwarding, the social security number (SSN) for the individual being sought, and a copy of the letter to be forwarded. The SSN is the key element used to access the appropriate tax account and retrieve a mailing address. If the requester does not furnish a SSN, the Service cannot process the request. Therefore, the SSN for the missing individual must be furnished by the requester.

02. If the Service locates an address for the recipient, it will forward the letter in an envelope bearing the Service’s return address. The Service will tell the recipient that: (1) the Service is forwarding the letter in accordance with current policy; (2) the Service has not divulged the recipient’s address, any other tax information, or the fact that the letter has even been forwarded; (3) the Service has no involvement in the matter aside from forwarding the letter; and (4) the decision of whether to respond is entirely up to the recipient.

03. The Service will not provide the requester with information concerning the results of the Service’s efforts. The Service will tell the requester only that it will attempt to forward the letter if it locates an address for the individual. If the requester provides the most current address for a recipient, and it is the same address that appears in the Service’s files, the Service will not forward the letter. All undeliverable letters will be destroyed.

04. Requests for letter forwarding assistance should be directed to the Disclosure Scanning Unit in Chamblee, GA, at the following address:

The Disclosure Scanning Unit will handle these requests as its workload permits (see Sec. 4.03. Scope). There is no charge for this service, except as provided in Section 5.05.

05. Requests involving 50 or more potential recipients, including multiple requests from a single individual or entity that can reasonably be aggregated to meet the 50 recipient threshold, will be processed under Project 753, Computerized Mailout Program. Project 753 is performed on a first-in first-out request basis. Mailouts are “queued” at service centers for processing. Generally, it will take 90 days from the Service’s acknowledgement of the request before the mailout can be performed. The requester will be charged for this service. The charge for Project 753 requests is subject to change but currently is approximately $1,750.00 plus $.50 per record. A more precise cost estimate will be given upon request. The Project 753 mailout program is only available for humane purposes as described in section 4 of this revenue procedure.

06. The request must contain (1) a brief explanation of the need for letter forwarding, and (2) one copy of the letter to be forwarded. In addition, the following statement should be conspicuously placed in the letter to immediately catch the attention of the recipient:

This revenue procedure applies to requests postmarked on and after August 31, 2012.

Revenue Procedure 94-22 is modified and superseded.

The principal author of this revenue procedure is Stephanie Sasarak of the Office of Chief Counsel (Procedure and Administration). For further information regarding this revenue procedure, contact Ms. Sasarak at (202) 622-4570 (not a toll-free call).