Keeping Your Balance: IRS releases new guidance on employee discount plans

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Earlier this year, the IRS issued guidance on qualified employee discount plans in a Field Attorney Advice memorandum. While this type of IRS release cannot be used as precedent, it does show us the current IRS thinking on the issue.

The taxpayer that was the subject of this Advice offered a fringe benefit plan that gave its employees an opportunity to name “designated individuals” eligible to receive discounts off of the published rates for its services. These designated individuals could include the employee, family members and even friends. The taxpayer noted that these discounts were often less than those offered to its largest customers.

In general, the Internal Revenue Code treats all types of income as taxable, unless there is a specific exclusion. The Advice pointed out that the tax regulations state that an employee can have income from fringe benefits—even though the benefit was actually provided for someone else, such as a spouse. However, the tax code also provides that various employee fringe benefits can be excluded from an employee’s W-2 if certain conditions are met. Among the various exclusions are qualified employee discounts.

In order to be considered a tax-exempt qualified employee discount, the discount must apply to a service or product offered by the business and cannot exceed the gross profit percentage of the price at which the property is offered to customers or, in the case of services, does not exceed 20 percent of the price at which the services are offered to customers. Any excess over these limits is considered taxable income to the employee.

In determining the amount of the discount, the price at which the property or service is offered to its customers at the time of the discount is controlling, and does not include any quantity discount (unless the employee actually purchases that same quantity). However, if the business makes customer sales of at least 35 percent at a discount, then that discount may be used as the price.

In this case, the taxpayer could not establish the facts to support the 35 percent rule, and therefore had to use the standard published rates. So the where the discount was in excess of 20 percent, the excess employee discounts was required to be included in the employee’s W-2. And based on the employee-only rule above, the full discounts taken for friends and family were also required to be included in the employee’s income. Finally, these amounts are subject to FICA/Medicare tax in addition to income taxes.

Many companies offer discounts to employees, as well as their employees’ family and friends. While a valuable incentive, this recent example shows that care must be taken to maintain the tax-free nature of this fringe benefit and to insure that there are no surprises in an employee’s W-2.

Now is a good time to review other types of tax-exempt employee fringe benefits. While not a comprehensive listing, here are many of the more popular tax-exempt benefits:

No additional cost services—This includes a service that is provided by the company to customers in the ordinary course of business, as long as the company does not incur any additional substantial cost by providing the service to the employee. Examples of this include unsold seats on an airplane, or hotel rooms that would otherwise go unsold. If the excess capacity is not available, then a discount not to exceed 20 percent is still non-taxable to the employee, as noted in the Advice above.

Working condition fringe benefits—This could include costs that would be deductible if incurred directly by the employee, such as business use of vehicles, or tuition for business-related courses.

De minimis fringe benefits—A company may treat the value of property or services that they provide to their employees as tax-free when the value is so small as to make it impractical to track. For example, this can include meal reimbursement for working overtime (on an occasional basis only), coffee and soft drinks, occasional tickets to sports or theater events, occasional parties, and personal use of office copy machines, as well as holiday or birthday gifts with a low fair market value. Remember that cash, gift certificates or gift cards can never be considered a de minimus fringe benefit; they are always taxable.

Qualified transportation fringe benefit—Within specified limits, employers can provide parking, transit passes and other commuting benefits.

Employer-provided cell phones—The value of the business use of an employer-provided cell phone, provided primarily for noncompensatory business reasons, is excludable from an employee’s income as a working condition fringe benefit. Personal use of an employer-provided cell phone, provided primarily for noncompensatory business reasons, is excludable from an employee’s income as a de minimis fringe benefit. Noncompensatory business reasons include the need to contact the employee at all times for work-related emergencies, the requirement that the employee be available to speak with clients at times when the employee is away from the office, or the need to speak with clients located in other time zones at times outside the employee’s normal workday. However, you can’t exclude from an employee’s wages the value of a cell phone provided to promote goodwill of an employee, to attract a prospective employee, or as a means of providing additional compensation to an employee.

Athletic facilities—You can exclude the value of an employee’s use of an on-premises gym or other athletic facility you operate from an employee’s wages if substantially all use of the facility during the calendar year is by employees, their spouses, and their dependent children.

Achievement awards—This exclusion applies to the value of any tangible personal property you give to an employee as an award for either length of service or safety achievement. The exclusion doesn’t apply to awards of cash, cash equivalents, gift certificates or other intangible property such as vacations, meals, lodging, tickets to theater or sporting events, stocks, bonds and other securities. For purposes of this exclusion, employees include current employees, certain former or leased.

And of course, let us not forget the most advantageous tax free benefits: employer-provided accident and health plans, as well as group life insurance coverage.

Burton S. Speer is a partner in the tax department at Mengel, Metzger, Barr & Co. LLP, and can be reached at [email protected] or (585) 423-1860.