On May 14, the United States Tax Court issued a decision in the case of Davison v. IRS, which should be the last word on tool rental schemes.
For a number of years, various promoters have come to automotive and truck shops, offering a plan whereby mechanics and their employers agree to split the mechanic’s wages with one portion of the wage being reclassified as the shop renting the mechanics’ tools. The idea is that while the fee for rental is an incometaxable event, it is not wages, and so not subject to Social Security, Medicare and Unemployment tax (FICA and FUTA). As a result, the employer saves about 8% of payroll and the employee gets an 8% “raise” due to lower taxes. What is usually left unsaid is that by reducing the wages, the mechanic will receive a lower social security benefit upon retirement. The promoters of these plans charged the employer a piece of the savings for running the program and issuing the second check.
About 20 years ago, several of these firms started lobbying the IAM to help promote these programs. Cash Management Systems (CMS) was one of the bigger players in this shady business. Inevitably the first question someone would ask is,“Is this legal?“ The CPA who helped set up CMS, Allen Davison, advised that the IRS knew about and blessed these tool rental programs even though the large national accounting firm he worked for and several others weighed in saying that the IRS would surely disallow the tool rental scheme. Rather than heed these warnings, Davison and CMS signed up shops all over the counrtry.
In 2008, the IRS began cracking down, auditing 24 employers who owed $4.6 million in back taxes. Three years later, Davison and his colleagues were banned from offering tax advice and Davison lost his
CPA license. After years of appeals, he finally was forced to pay penalties that were originally assesed in 2013.