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SuraLinkBy: Cooper Melvin J.D., Staff Accountant
Recent news has brought a focus on employer-provided fringe benefits and the consequences to employees and businesses if accounting is improper. Compliance with accounting for fringe benefits falls on employers. The consequences of failure to comply can be significant, for both income and payroll tax purposes. This article surveys some key concepts in this area and highlights some benefits that are not taxable and the extent to which they can be excluded from employees’ gross income.
§ 61 of the Internal Revenue Code (the “Code”) provides the underlying concept that a taxpayer’s gross income includes “all income from whatever source derived,” unless otherwise specifically excluded. This section of the Code also clearly states its applicability to employees by explaining gross income includes “Compensation for services, including fees, commissions, fringe benefits, and similar items.”
The basic working premise for an employer providing fringe benefits to an employee is that the fringe benefit is to be included in gross income unless it is excluded by the Code. The most common types of excludable benefits that employers provide consist of the following:
- § 132 exclusions:
- No-additional-cost services
- Qualified employee discounts
- Working condition fringe benefits
- De minimis fringe
- Qualified transportation fringe
- Qualified moving expense reimbursement
- § 105 and § 106 Certain health benefits and sick leave
- § 119 Meals and lodging for employer convenience
- § 127 Educational assistance
- § 129 Employer-provided dependent care
- § 137 Adoption assistance
No-additional-cost services
A no-additional-cost service is a service provided by an employer to an employee for personal use that is also provided to customers within the ordinary course of their line of business and that requires no substantial cost to provide for employees. An example is an airline allowing an employee to fill a vacant seat on an airplane. Flights are within the ordinary course of the line of business of airlines. Furthermore, allowing an employee to fill a vacant seat does not cost the airline the price of a ticket (because the seat was not going to be filled) nor do they have to pay anything extra for the employee to ride, other than maybe an insubstantial snack or soda. Thus, the airline can allow that employee to ride without including the cost of the flight in the employee’s gross income. There is no limit on the excludability of this provision as long as both parts of the test are met.
Qualified employee discounts
A qualified employee discount is one that does not exceed the gross profit percentage of the price at which it is being offered to customers, with respect to property. Furthermore, with respect to services, discounts are qualified if they do not exceed a 20 percent discount off the price offered to customers. Note, this test, as it relates to services, is only applicable if the service is not excludable as a “no-additional-cost service” because it does not meet one or both two-part tests.
An example would be if the airline allows the airline employee, in the previous example, to book their flight ahead of time at a discount, thus not knowing that the seat would otherwise be vacant. This is an additional cost because the airline might fill the seat at full price, if not for the employee booking the seat ahead of time. Thus, this example falls under the qualified discount since it fails the no-additional-cost services test.
Working condition fringe benefits
A working condition fringe benefit is any expense employers pay on behalf of an employee that would be deductible by the employee, if paid by the employee on their own behalf. This provision of the Code is unaffected by the suspension of certain miscellaneous individual deductions through 2025 under the Tax Cuts and Jobs Act of 2017, nor is it affected by the employees that do not itemize deductions. Examples of working condition fringes include allowing an employee to use a company car for business purposes, providing furniture for an employee’s office, etc. However, such exclusions are limited to the portion used for business purposes or incidental personal purposes only. Therefore, any portion of use that is purely personal is included the employee’s gross income at fair market value less the cost the employee pays to reimburse the employer for such benefit.
De minimis fringe benefits
De minimis fringe benefits are property or services provided that are so small in value and frequency that accounting for them is unreasonable. Gift certificates that are redeemable for general merchandise or have a cash equivalent value are not de minimis benefits and are taxable. A certificate that allows an employee to receive a specific item of personal property that is minimal in value, provided infrequently, and is administratively impractical to account for, may be excludable as a de minimis benefit, depending on facts and circumstances.
Qualified transportation fringe
A qualified transportation fringe includes “any employer-provided transportation in a “commuter highway vehicle” if such transportation is in connection with travel between the employee’s residence and place of employment, any transit pass, qualified parking, and any qualified bicycle commuting reimbursement.”
To qualify as a commuter highway vehicle, the vehicle must seat at least six adults, in addition to the driver; and, at least 80% of the time, both of the following must be true: 1) mileage is reasonably expected to be purposed for transportation between residence and work; and 2) at least 50% of the seating capacity is used, not including the driver. Additionally, transit passes and commuter highway vehicles are only excludable up to $270 a month, in aggregate.
Qualified parking includes parking at or near work or, at or near the point of where the employee parks to commute. Under no circumstances is employer-provided residential parking excludable from an employee’s gross income. Qualified parking passes are excludable up to $270 a month, in addition to the $270 per month threshold for transportation expenses.
Qualified moving expense reimbursement
Pursuant to the Tax Cuts and Jobs Act of 2017, this exclusion is suspended until 2026. However, when applicable, qualified moving expenses are employer-provided expenses that would be deductible by employees under § 217, if paid on their own behalf. § 217 allows individuals to deduct moving costs in connection with relocating to a new place of work.
Health benefits and sick leave
Amounts received by an employee through employer-provided accident or health insurance are included in employees’ gross income to the extent they are “attributable to contributions by the employer which were not includible in the gross income of the employee or, are paid by the employer.” However, such amounts are not included to the extent they are reimbursement for out-of-pocket expenses incurred for medical care. An example of a fully includable amount is disability pay while out of work due to injury, to the extent such pay is not considered reimbursement for expenses related to injury treatment. Generally, employer contributions to an insurance plan are not taxable to the employee except for amounts used for qualified long-term care services. Note that special rules and reporting requirements beyond the scope of this summary can apply to greater than 2% owner-employees of S corporations (and also to partners in a partnership).
Meals and lodging for the convenience of the employer
Meals or lodging that an employer provides to employees or their families, for the convenience of the employer, is excluded from an employee’s gross income only if the meals are furnished on business premises or the employee is required to accept lodging on the business premises as a condition of his employment. All meals furnished on businesses premises are treated as furnished for the employers’ convenience if more than half of the employees are provided such meals.
Cafeteria plans
Cafeteria plans are plans where all participants are employees and the participants may choose between two or more benefits consisting of cash and other qualified benefits. Cafeteria plans are excluded from gross income of employees, with few exceptions. Highly compensated employees are excluded from tax-free treatment if the plan discriminates in favor of such employees in regard to eligibility for the plan or in regard to the amount of employer contributions to the plan in favor of such employees. In addition, cafeteria plans provided to key employees are only excludable up to 25% of the total benefits for all employees under the plan even if the plan does not discriminate in favor of such employees. Greater than 2% owner-employees of an S corporation, and partners in a partnership, cannot participate in a cafeteria plan, although they may be able to make a tax deduction outside of the cafeteria plan for medical expenses.
Education assistance
Employees can exclude up to $5,250 of employer-provided educational assistance. However, the education assistance provided must be related to the employee’s employment (i.e. education assistance for an engineer must be related to educational costs to advance the employee’s engineering knowledge) and it must not favor highly compensated individuals over other employees. Furthermore, only 5% of amounts can go toward key employees.
Dependent care
Employees can also exclude up to $5,000 ($2,500, if married filing separately) of employer-provided childcare. If the employee or the employee’s spouse earns less than $5,000 (when considered independently), then the exclusion is limited to the lesser of the two earned incomes. Furthermore, employer-provided childcare must not discriminate in favor of highly compensated employees.
Adoption assistance
Qualified adoption expenses paid on behalf of an employee are not included in gross income, except to the extent it exceeds $10,000. This exclusion begins to phase out for taxpayers with adjusted gross income over $150,000 and the exclusion is expanded for adoption of children with special needs.
Employee business expense reimbursements – non-accountable vs. accountable plans
Another common employer practice – the reimbursement of employee business expenses – should be considered when discussing the exclusion from (or inclusion in) income of payments by an employer to an employee. These reimbursements can be anything from meals with clients, travel, gas mileage, professional dues, and much more. There are two types of plans for employee reimbursements, non-accountable and accountable.
Under a non-accountable plan, an employer typically gives the employee cash and the employee pays for a business expense with the cash and pockets any excess without tracking expenses. This reimbursement is fully taxable to the employee. Under the Tax Cuts and Jobs Act, the employee currently has no offsetting employee business expense deduction.
Under an accountable plan, employees track their expenses by keeping receipts, documenting the purpose of the expense, and submitting that documentation to employers for reimbursement. Under this plan, the reimbursement is generally excluded from the employee’s gross income. As with every expense, reimbursements are only deductible by the employer if related to legitimate business expenses.
Conclusion
In conclusion, it is complicated to determine what is excludable and includable at the employee level and the ultimate liability falls on the employer to correctly document these transactions. Therefore, it is important to seek professional help when questions arise regarding fringe benefits and how it affects your business or your personal tax situation. The repercussions of improper reporting and tracking can be significant. For additional discussion of employee fringe benefits, please see IRS Publication 15-B. Please contact your BMSS professional if you have any questions regarding how the benefits you provide to employees may be affecting your business.