If you do not have a tool reimbursement plan for your employees you may wish to incorporate this if you require them to supply their own hand tools on the job site.  The tax code allows properly configured tool reimbursement allowances to be tax free to the employee and deductible to the employer.

Tool reimbursements are also not subject to payroll taxes if it is made under an accountable plan.  To be treated as an accountable plan, an expense reimbursement must meet all of the following requirements:

  • Business connection – the reimbursed expense must be allowable as a deduction and it must be paid or incurred while performing services as an employee of the employer.
  • Substantiation – the employee must submit enough information to allow the employer to identify the specific nature of each expense and attribute the expense to the employer’s business activity within a reasonable period of time.
  • Return of excess – the employee must return to the employer within a reasonable period of time any amount the employer paid in excess of the employee’s substantiated expenses.

If the arrangement fails any of the requirements or shows a pattern of abuse, the amounts paid under the arrangement are treated as paid under a “non accountable plan” and are thus taxable (included in the employee’s gross income, reported as wages or other compensation on the employee’s Form W-2, and are subject to withholding and payment of employment taxes). 

Some employers have decided to reduce their payroll expenses by a specific amount but supply the same cash in the form of the tool reimbursement plan. 


Tool Reimbursement Plans – Do You Meet the IRS Guidelines?