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The California Supreme Court has taken on a little-noticed employment case that will determine whether an employer must reimburse employees for specific out-of-pocket job expenses, or if it can simply raise their pay and call things even. The suit, filed by two Southern California salesmen for PennySaver advertising weeklies, relies on a 1937 state labor statute requiring employers to indemnify workers for job-related expenses. The law does not specify how that should be done � through expense payments or by adjusting salaries and commissions. The appeal is likely to catch the attention of labor practitioners outside California. That’s because more than a dozen other states have similar statutes or common law requirements, including Florida, Illinois, Kansas, New York, and Pennsylvania, according to plaintiffs attorney Kathleen Carter of Hollins Schechter in Santa Ana, California. “The practical ramifications are alarming,” says Carter. “Why would any employer use a mileage rate or expense accounts, with separate checks for expense reimbursement, when a simple ‘your salary covers expenses’ comment is recognized as a facially acceptable plan under [Labor Code] section 2802?” Carter adds: “This is a very important case because it could have an impact on virtually every business [in California].” Salesmen Frank Gattuso and Ernest Sigala sued Harte-Hanks Shoppers Inc., a marketing company that distributes 8 million advertising publications a week in California. Gattuso and Sigala sought reimbursement for driving expenses connected with the job. The two argued that increased pay instead of reimbursement would effectively nullify the law and create new tax problems. Harte-Hanks attorney Raymond Kepner, of the Los Angeles office of Chicago’s Seyfarth Shaw, says, “If the plaintiffs’ argument were accepted, it would call into question mileage allowances and per diems and a host of flexible arrangements employers have worked out through enforceable agreements or policies.” The state law generally requires companies to indemnify their employees for losses incurred in the discharge of their duties. A state appeals court held that employers are permitted to increase salaries and commissions rather than reimburse actual expenses. The California Court of Appeal for the Second District held that the expenses “could be discharged through reasonable agreements or policies,” says Kepner. But Carter says folding expenses into salary would run afoul of tax law. Employees would pay higher taxes on the dollars that constitute expense reimbursement and that might not be adequately offset by expense deductions. Also, if a company were to overpay the actual expenses, the Internal Revenue Service would want to collect tax on the overpayment as income, or have the employee return the overpayment to the boss. Both sides expect labor and management groups to weigh in on the appeal. It’s likely to be scheduled for argument at the end of 2006. A decision is expected early next year. A version of this story originally appeared in The National Law Journal, a sibling publication of Corporate Counsel.

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