Nontaxable employee fringe benefits - Qualified employee discounts

David Repp, Iowa Taxation Law, Des Moines Iowa, Dickinson Law Firm

Posted on 05/19/2017 at 12:00 AM by David Repp

Despite recent Congressional attempts to close loopholes and raise revenues, provisions in the Tax Code still exist that allow employers to provide and deduct certain fringe benefits that are likewise not included in the employee's income. For the small, closely-held corporation, where owners often time make up the majority of the employees, this means an ability to deduct the cost of products or services that ordinarily would be "personal" in nature. For the larger business, goodwill among employees can be enhanced by offering such tax deductible fringe benefits. In addition, fringe benefits are excluded from an employee's wage base for computing tax withholding, FICA, FUTA, and RRTA. The following are examples of fringe benefits that are deductible by the employer and not included in the employee's income:

Qualified Employee Discounts qualify for exclusion if the discount relates to qualified property or services of the employer. Qualified property or services include such property or services that are offered for sale to customers in the ordinary course of the line of business of the employer in which the employee performs substantial services. Qualified property does not include property sold or produced by another, unrelated employer. CCA 200923029. Qualified property does not include real property or property held for investment. 

For services, the discount must not exceed 20% of the price at which the service is offered to nonemployee customers in the ordinary course of business. Any discount in excess of 20% must be included in the employee's gross income.  For example:

Example 1  A commercial airline gives each employee a pass for a free round trip coach ticket with a confirmed seat for any of the airline's destinations. Assume that neither the no-additional-cost service exclusion, nor any other statutory exclusion, applies to an employee taking such a flight for personal purposes. Up to 20% of the employee discount is excludable, so if a non-employee customer would pay $300 for a comparable ticket, the employee would exclude $60, and include $240 in gross income.

For property, the discount must not exceed the gross profit percentage during the taxable year immediately preceding the taxable year in which the discount is available for a particular line of business. Likewise, any discount in excess of the gross profit percentage is included in the employee's gross income. For example:

Example 2 If the aggregate amount of sales of property in an employer's line of business for the prior taxable year was $800,000, and the aggregate cost of the property for the year was $600,000, the gross profit percentage would be 25 percent ($800,000 minus $600,000 divided by $800,000).

An employee for purposes of qualified employee discounts is defined the same as an employee for purposes of no additional cost services. Likewise, an employer cannot discriminate in favor of highly compensated employees.

The material in this blog is not intended, nor should it be construed or relied upon, as legal advice. Please consult with an attorney if specific legal information is needed. 

- David Repp


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