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By Howard Lapin

In today's highly competitive global economy, employers are frequently searching for new and innovative ways of compensating their employees. One area that has received increasing attention is fringe benefits. While health care has received the lion's share of attention, there are other fringe benefits employers can use to achieve a more productive workforce.

Certain fringe benefits are excluded from an employee's gross income under a specific statute. These include health coverage (IRC Sec. 105 and 106), group-term life insurance up to $50,000 (IRC Sec. 79), educational assistance (IRC Sec. 127), dependent care (IRC Sec. 129), and group legal services (IRC Sec. 120). These code sections usually condition the exclusion from gross income on adherence to rules prohibiting discrimination in favor of highly compensated employees, with the rules differing, depending on which fringe benefit is being considered.

Prior to the enactment of the Deficit Reduction Act of 1984 (DEFRA), there was substantial uncertainty regarding the treatment of other types of fringe benefits such as employee discounts. Fringe benefits were usually treated as nontaxable mostly on the basis of historical treatment instead of any specific statutory authority. DEFRA added IRC Sec. 132 that specified four types of nontaxable fringe benefits: no-additional-cost services, qualified employee discounts, working condition fringe benefits, and de minimis fringe benefits.

In 1992, IRC Sec. 132 was amended to add qualified transportation fringes as a fifth category. Any fringe benefit provided to an employee is now taxable unless it is excludable under a specific code section. Fringe benefits excludable from gross income under IRC Sec. 132 are also excludable for purposes of determining income tax withholding, FICA, and FUTA taxes.

No-Additional-Cost Services

A fringe benefit is a no-additional-cost service in two cases. One is if the employer offers the service for sale to customers in the ordinary course of the line of business in which the employee performs substantial services. The second is if the employer incurs no substantial cost in providing the service to the employee, taking into account any foregone revenue. Examples of no-additional-cost services include an airline providing standby flights to employees and a telephone company providing free phone service to its employees.

As noted above, the services must be offered to an employee from the same line of business for which the employee is performing substantial services. There are, however, exceptions to the line of business rule under certain grandfather rules pertaining to retail stores, airline affiliates, and other situations. In addition, unrelated employers in the same line of business may, under certain conditions, enter into a reciprocal agreement to provide no-additional-cost services to each other's employees. For example, two airlines could enter into a reciprocal agreement to provide free standby flights to each other's employees.

No-additional-cost services may be provided to employees; former employees, who terminated due to retirement or disability; and spouses, surviving spouses, and certain dependent children of these persons. Parents of current employees may receive free standby flights from airlines.

No-additional-cost services must be provided on a nondiscriminatory basis. If there is discrimination in favor of highly compensated employees, then such employees must include the value of the services in income.

Qualified Employee Discounts

A qualified employee discount is a discount on property that does not exceed the employer's gross profit percentage or services in which the value does not exceed 20% of the price charged to customers. Real estate and personal property of a kind commonly held for investment are not eligible for a qualified employee discount.

One employer cannot provide qualified discounts to the employees of another employer. There is, however, an exception for leased areas of a department store. Under the exception, the employees of the leased portion are eligible to receive qualified employee discounts from the department store, and the employees of the department store can receive discounts from the retailer leasing the space.

The same persons who are eligible to receive no-additional-cost services are eligible to receive qualified employee discounts with the exception of parents of employees. Discounts must be nondiscriminatory to be excludable from the income of highly compensated employees.

Working Condition Fringe Benefits

A working condition fringe benefit is any property or service provided to an employee that, if the employee had paid for the property or service, would have been deductible as a business expense under IRC Sec. 162 or depreciable under IRC Sec. 167.

Examples of working condition fringe benefits include supplying a bodyguard/chauffeur, provided there is a bona fide business-oriented security concern; subscriptions to business periodicals; on-the-job training; the value of the use of a company car or airplane for business purposes; and providing products to employees for testing and evaluation, but only if certain conditions are met.

Employer provided physicals are specifically excluded from the definition of working condition fringe benefits regardless of whether the employee would be entitled to deduct the expense if the exam were paid for.

Working condition fringe benefits may only be provided to employees. However, these benefits may be provided on a discriminatory basis.

De Minimis Fringe Benefits

A de minimis fringe benefit is property or service, the value which is so small that accounting for the benefit would be unreasonable or administratively impractical.

Examples of de minimis fringe benefits include typing of a personal letter by a company secretary; coffee, donuts, and soft drinks for employees; personal use of a copying machine provided the machine is used at least 85% of the time for business; occasional company parties and picnics; traditional holiday gifts; local telephone calls; occasional theater and sporting event tickets; and flowers or fruit under special circumstances such as illness.

The regulations specify certain benefits that will not be considered de minimis. These are season tickets to the theater or sporting events, commuting use of a company car for more than once a month, membership in a private country club or athletic facility, and use of employer-owned or leased recreational facilities.

Under IRS Notice 89-110, group-term life insurance payable when an employee's spouse or dependent dies will be excludable provided the amount does not exceed $2,000.

Usually any individual can receive a de minimis benefit and exclude the benefit from gross income. There are no discrimination rules that apply to de minimis fringe benefits.

Qualified Transportation Fringes

A qualified transportation fringe includes transportation in a commuter highway vehicle between work and home, a transit pass, or qualified parking.

A commuter highway vehicle includes any highway vehicle that seats at least six adults, excluding the driver and at least 80% of the mileage used is for employees commuting between home and work with at least half the seats (excluding the driver) occupied by employees.

A transit pass includes any fare card, token, pass, or similar item that entitles a person to transportation on any public or private mass transit or in a commuter highway vehicle provided by a person in the business of transporting persons. The exclusion for transit pass and commuter highway fringe benefits could not exceed a total of $60 per month for an employee for 1994.

Qualified parking includes parking provided to an employee on or near the business premises of the employer or near a location from which the employee commutes in a commuter highway vehicle or carpool. Parking at or near an employee's residence does not qualify for any exclusion. The exclusion for qualified parking for 1994 was limited to $155 a month.

Qualified transportation fringe benefits may be provided only to employees, but there are no discrimination requirements. Howard Lapin, CPA, is a consultant, based in Chicago, IL, who specializes in employee benefit plans. *

Reprinted with permission of Insight, the magazine of the Illinois CPA Society, November 1995.


Michael Goldstein, CPA

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