By Steve Jones

Recently, the U.S. Court of Appeals for the 8th Circuit—which covers Arkansas, Iowa, Minnesota, Missouri, Nebraska, North Dakota, and South Dakota—held that an employer could treat payments to employees as nontaxable expense payments when reporting to the IRS and, simultaneously, as wages for purposes of minimum wage calculations under the Fair Labor Standards Act (FLSA).

Background

In 2003, freight carrier and transportation logistics company Werner Enterprises implemented an optional payment plan that compensated drivers employed in positions requiring them to travel and spend nights away from home on a regular basis.

The payment plan offered nontaxable, mileage-based "payments" to drivers who chose to participate. To provide the payments free of employment and income taxes, the plan had to qualify as an "accountable plan" under Internal Revenue Service (IRS) Treasury regulations. And to qualify as an accountable plan, it needed to meet the IRS regulations' so-called business connection, substantiation, and return of excess expenses requirements. To that end, when it established the plan, Werner represented to the IRS, in part, that the payments at issue were reimbursements for travel expenses that employees were reasonably expected to incur.

Without getting bogged down in the technicalities, it's key to note that because the payments weren't subject to employment and income tax withholding, the plan's primary effect was to cause participating drivers to receive more money in the form of take-home pay in their weekly paychecks. Participating experienced drivers received one portion of their pay based on an applicable mileage rate, subject to taxes, and the other portion as payments consisting of a nontaxable sum based on the applicable payment plan mileage rate for days spent driving away from home overnight.

Drivers electing not to participate received all of their pay based on various per-mile rates, subject to employment and income taxes. To the extent nonparticipating drivers incurred meal and other incidental expenses while traveling, they could validate those expenses with receipts and deduct them on their annual income tax returns. Participating drivers, however, could deduct such expenses only on their annual tax returns when the

Drivers File Suit

Participating drivers filed a class action against Werner, alleging that its inclusion of these payments in its minimum wage calculation under the FLSA was improper, and without their inclusion, the participating drivers weren't receiving the minimum wage.

According to the drivers, because the payments were reimbursements for traveling expenses incurred in furtherance of Werner's interests, they should be excluded from the regular rate calculation established under the FLSA. The company disagreed, contending that for purposes of calculating the employees' regular rate, these same payments were not reimbursement for reasonable travel expenses, but rather were wages, since they actually compensated the drivers for services rendered.

It asserted that it established its payment plan as a recruiting tool to attract drivers because other trucking companies operated similar plans providing untaxed payments for meals and incidental expenses.

The drivers focused a large part of their argument on what they claimed was Werner's contradictory stance under the FLSA. They claimed the representations it made to the IRS (that the payments were reimbursements for travel expenses it reasonably expected its drivers to incur) and those it made to the U.S. Department of Labor (DOL) that they were wages were legally incongruent, and the payments should be excluded from the regular pay rate calculation under the FLSA.

Lower Court Agreed with Werner

The district court reviewed the FLSA's statutory scheme and the supporting DOL regulations and decided that to determine whether the payments should be included in the regular rate calculation required an evaluation of (1) whether they were reimbursements for expenses incurred solely for Werner's benefit or convenience and (2) whether they approximated actual expenses.

Breaking the analysis down and relying on the persuasive authority of the DOL Field Operations Handbook, as well as court precedent analyzing per diem payments and regular rate calculations, the district court found that the payments were part of the regular rate for minimum wage purposes.

A critical factor in reaching this conclusion was that the payments always reflected hours worked (mileage driven being directly related to hours worked) and functioned as a wage rather than a true per diem expense reimbursement.

The court also relied on the fact that the payments, when added to the taxable wages received by the participating employees, were "suspiciously close" to the total taxable wage of nonparticipants. The district court found all these indicators pointed it toward the conclusion that the payments' form and purpose were intended to act as remuneration for work performed under the FLSA.

Test on Appeal: Employer's Benefit or Employee's?

The court of appeals, as a preliminary matter, noted that under the FLSA, an employee's regular rate includes all remuneration paid to or on behalf of the employee, as long as it isn't prohibited by one of eight statutory exclusions listed in the Act.

One of those listed exclusions is for reimbursements for certain expenses incurred in the furtherance of the employer's interests, including "reasonable payments for traveling expenses, or other expenses . . . and other similar payments to an employee which are not made as compensation for his hours of employment."

Language in the regulations governing this provision makes it clear, however, that not all payments for expenses incurred while an employee is away from home are necessarily excluded from the employee's regular rate for minimum wage purposes. For example, to be excludable from wages, the expenses must be for the employer's benefit or convenience. If the reimbursement is for expenses normally incurred by the employee for his own benefit, then they are included as part of the employee's wages.

Applying the Test

The 8th Circuit noted that applying this test is very fact-intensive and depends on the specifics of each case. In affirming the district court's decision, it relied on several factors, but the key factor was that the payments were based on hours worked (as reflected by the miles driven). The court noted it is well-established that per diem payments that vary with the amount of work performed are part of the regular rate. It cited several cases and the DOL handbook in support of this conclusion.

Other factors the appeals court noted were:

1. The form and purpose of the payments suggest they were intended to act as remuneration for work performed;
2. They were unrestricted in that the employees could spend them in any manner and weren't required to report expenses or provide receipts; and
3. Werner introduced them as a means to attract new employees by maximizing take-home pay.

The court concluded that each of the factors additionally established that the payments were remuneration for employment rather than reimbursement for expenses.

Bottom Line

On its face, this case may seem confusing because it allowed Werner to take the apparently conflicting positions of treating payments as expenses for tax purposes and as wages for FLSA purposes. However, it really is more akin to deciding whether to pay employees less but reimburse their business-related expenses or pay them more and allow them to claim the expenses as tax deductions on their personal tax returns.

The real loser in this is the U.S. Treasury—no Medicare or Social Security taxes are being paid on the payments, and no advance use of the individual's tax obligation occurs because no withholding is made. This does demonstrate, however, an IRS-approved expense reimbursement program that can result in more net money for employees who qualify and can reduce the employer's Medicare, Social Security, and other payroll-based contributions.

Steve Jones is an attorney Jack Nelson Jones & Bryant, P.A and an editor of the Arkansas Employment Law Letter. He can be reached at sjones@jacknelsonjones.com.