IRS denies Corporate reimbursement to employee.?

Question

If a corporation reimburses an employee for an expense that is later denied by the IRS, what happens?

For example, let's say in 2006, a corporation reimburses an employee $1,000 for education. In 2008 during an audit of the company, the IRS denies the expense saying that it doesn't meet their guideline for reimbursable education (for whatever reason...this is a hypothetical example). Does the company need to reissue the 2006 W-2 showing an additional $1,000 in compensation? That seems particularly cumbersome since the employee would then need to file an amended return and may have to reclassify Roth contributions etc. The employer would have to pay FICA for that year. Ouch! Or, can the company request that the employee pay back the $1,000 as if it never happened? Or, would the company simply change the employee's 2008 W-2 to show the $1,000 (even though it went to the employee in 2006)?

Any help would be much appreciated.

Answer 1

If the IRS ruled that the reimbursement was taxable income, then the W-2 would be reissued and yes, this could have a domino effect on the employee's 1040.

Witness the current mess with 409 plans.

Answer 2

On this one the company rolled the dice and lost. They clearly valued the education enough to reimburse for it, so the IRS ruling is against them and not the employee. No revised w-2 is called for because the money isn't earned income, since the employee took the education in good faith. Central question: if the ed. had not been reimbursable at the time, would the employee have taken the classes in the first place? That's the standard of good faith, and I rest my case. Advice to employee: keep your mouth shut--why poke a stick into a hornet's nest just see if anybody's home?