Tool Allowances are Includible in Gross Income and Subject to Withholding
In a number of industries, employees provide their own tools to perform services and are reimbursed for the cost of the tools by their employers. Whether or not such amounts are included in the employee's income and wages is governed generally by whether or not the employer makes payments to the employee under an accountable plan. Expenses reimbursed under an accountable plan are excluded from income and wages; expenses that are reimbursed under a non-accountable plan are taxable.
In Rev. Rul.2005-52, the IRS clarifies that employers using accountable plans to reimburse employees for the cost of providing tools must substantiate the expenses reimbursed and, to the extent the plan provides payments before expenses are incurred, the plan must require the employee to return amounts in excess of the substantiated expenses. In particular, the ruling clarifies that an accountable plan may not use estimates to substantiate the amount of the expenses.
Therefore, any arrangement that is not an accountable plan in which tool allowances are paid under the arrangement must be included in the employees' gross income, reported as wages on the employees' Forms W-2, and are subject to withholding and payment of federal employment taxes.
Auto Reimbursements to employees fall under the same rules as tool allowances, arrangements.