New tax rules have made the once-common tool and car allowances pretty much dead as expense reimbursment methods. A taxpayer employed a number of service technicians who performed their work at customers' work sites using their own tools, ranging from simple wrenches to power tools and computer analysis equipment.

A promoter approached the taxpayer and convinced the taxpayer that he could save on taxes by converting part of the technicians' W-2 wages to an allowance for tools.

The effect of the promoter's claim was that the employee-technicians would receive the exact same compensation, but that some of that compensation would now be for the tool allowance and that would save both the employer and the employees from FICA and Medicare taxes

The tool allowance failed the three requirements for an employee expense reimbursement.

• First, the plan did not reimburse business expenses actually paid or incurred.
• Second, the plan did not require substantiation of the elements of the expense in the form of an expense account or other written documentation.
• Third, the plan did not require the return of reimbursements in excess of the expenses incurred.

The IRS said that this taxpayer exhibited a plan of abuse in this allowance and that all amounts under the plan shall be treated as made under a nonaccountable plan. This creates a problem for the taxpayer as now he should have counted the reimbursements as wages, but did not. Thus, he is subject to all the penalties for failure to pay these amount as wages, including the 100 percent trust fund penalty.

The old-fashioned allowance accounts have long been trouble in the tax law. Protect yourself or your corporation. Make sure that your expense reimbursement methods meet the three rules for reimbursement.

In general, the records for reimbursement are the same records you need as an individual taxpayer to claim the deduction. Thus, the car allowance is out. But a reimbursement of all care expenses, including Section 179 expensing and depreciation is appropriate.

As a one-owner or husband-and-wife-owned business, you should strive to get all expenses on the business's books. Follow the three rules above to make sure that both you and your business are protected when expenses are reimbursed.