Late Form W-2s Doubled, Penalties to Come

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July 12, 2017

The earlier filing deadline on January 31 for Forms W-2 resulted in more than double the number of late-filed returns, according to Tim McGarvey, Social Security Administration branch chief, who was speaking on an IRS payroll industry conference call.  He said that, to date, the SSA has received close to 50,000 late Form W-2 submissions, compared to an average of 25,000 late submissions annually in the past few years.  In response to an inquiry from the Tax Withholding & Reporting Blog, Mr. McGarvey indicated that the 50,000 submissions represent approximately 4 million late-filed 2016 Forms W-2.

In addition to the jump in the number of late-filed returns, Mr. McGarvey said that the number of Forms W-2c filed has also increased dramatically—up 30 percent from last year.  In response to an inquiry, Mr. McGarvey reported that the SSA has received approximately 2.7 million Forms W-2c in 2017, with some 2.2 million of those correcting 2016 returns.  That compares to a total of approximately 2 million Forms W-2c processed in 2015.

The January 31 deadline for filing and furnishing recipients with the Form W-2 and a Form 1099-MISC that reports nonemployee compensation (Box 7) became required under the Protecting Americans from Tax Hikes (PATH) Act to combat identity theft and fraudulent claims for refund (see prior coverage).

Late filers and those that struggled to provide accurate filings by the January 31 deadline should take steps now to prepare for the 2017 filing season.  Employers who provide taxable non-cash fringe benefits (such as the personal use of company cars) may want to consider imputing income for those benefits using the special accounting rule and flexibility in Announcement 85-113, if they are not already doing so.  Announcement 85-113 permits employers to treat non-cash fringe benefits as received on certain dates throughout the year (such as on the first of each month, each quarter, semi-annually, or annually).  It also allows employers to treat the value of non-cash fringe benefits actually received in the last two months of the calendar year as received in the following calendar year.  Making use of these rules can ease the year-end payroll crunch.  The earlier employers can provide copies of Forms W-2 to employees, the greater the chance there is for employees to identify errors and request corrections before the January 31 filing deadline.

Tax Court Expands Section 119 Exclusion in Boston Bruins Decision

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June 27, 2017

In a much anticipated decision, the U.S. Tax Court ruled yesterday that “the business premises of the employer” can include an off-premises facility leased by the employer when its employees are on the road.  The decision in Jacobs v. Commissioner addressed whether the employer (in this case, the professional hockey team, the Boston Bruins) was entitled to a full deduction for the meals provided to the team and staff while on the road for away games.  The debate arose after the IRS challenged the full deduction and asserted that the employer should have applied the 50% deduction disallowance applicable to meals by section 274(n) of the Code.

Under section 162 of the Code, an employer may deduct all ordinary and necessary business expenses.  However, in recognition that the cost of meals is inherently personal, the Code limits the deductions for most business meal expenses to 50% of the actual expense under section 274(n), subject to certain exceptions.  The exception at issue in Jacobs allows an employer to deduct the full cost of meals that qualify as de minimis fringe benefits under section 132(e) of the Code.  In general, this includes occasional group meals, but would not typically include frequently scheduled meals for employees travelling away from home.  (For this purpose, home is the employee’s tax home, which is typically the general area around the employee’s principal place of employment.)  However, under Treasury Regulation § 1.132-7, an employer-operated eating facility may qualify as a de minimis fringe benefit if, on an annual basis, the revenue from the facility is at least as much as the direct operating cost of the facility.  In other words, an employer may subsidize the cost of food provided in a company cafeteria, provided the cafeteria covers its own direct costs on an annual basis and meets other criteria (owned or leased by the employer, operated by the employer, located on or near the business premises of the employer, and provides meals immediately before, during, or immediately after an employee’s workday).

The Bruins’ owners argued that they were entitled to a full deduction because the banquet rooms in which employees were provided free meals qualified as an employer-operated eating facility.  That may leave some of our readers wondering, “How can a facility that is free have revenue that covers its direct operating cost?”  The key to answering that question lies in the magic found in the interface of sections 132(e)(2)(B) and section 119(b)(4) of the Code.  Under section 132(e)(2)(B), an employee is deemed to have paid an amount for the meal equal to the direct operating cost attributable to the meal if the value of the meal is excludable from the employee’s income under section 119 (meals furnished for the “convenience of the employer”) for purposes of determining whether an employer-operated eating facility covers its direct operating cost.  In turn, section 119(b)(4) provides that if more than half of the employees who are furnished meals for the convenience of the employer, all of the employees are treated as having been provided for the convenience of the employer.  Working together, if more than half the employees are provided meals for the convenience of the employer at an employer-operated eating facility, the employer may treat the eating facility as a de minimis fringe benefit, and deduct the full cost of such facility.

The IRS objected to the owners’ treatment of the banquet rooms as their employer-operated eating facilities and disallowed 50% of the meal costs.  The Tax Court succinctly explained that the Bruins’ banquet contracts constituted a lease of the rooms provided for meals and that the contracts also meant that the Bruins operated the facilities under Treasury Regulation § 1.132-7(a)(3).  In doing so, the Tax Court summarily dismissed the IRS’s argument that the payment of sales taxes meant that the contracts were not contracts for the operation of an eating facility but instead the purchase of meals served in a private setting.

Having determined that the first two criteria were satisfied, the Tax Court turned to the question of whether the hotel banquet rooms constituted the “business premises of the employer.”  The court looked to a series of cases indicating that the question was one of function rather than space.  Relying on those cases, the court determined that the hotels were the business premises of the employer because the team’s employees conducted substantial business activities there.   The court seemed to put significant weight on the fact that the team was required to participate in away games, necessitating it travel and operation of its business away from Boston.  The Tax Court was unpersuaded by the IRS’s quantitative argument that the team spent more time working at its facility in Boston than at any individual hotel and its qualitative argument that the playing of the away game was more important than the preparation for the game that took place at the hotel.

Having determined that the hotel banquet rooms were an employer-operated eating facility, the Tax Court next addressed whether it qualified as a de minimis fringe benefit because more than half of the employees who were furnished meals in the banquet rooms were able to exclude the value of such meals from income under section 119 of the Code.  The court determined that this requirement was satisfied because the meals were provided to the team and staff for substantial noncompensatory business reasons.  The business reasons included: ensuring the employees’ nutritional needs were met so that they could perform at peak levels; ensuring that consistent meals were provided to avoid gastric issues during the game; and the limited time to prepare for a game in each city given the “hectic” hockey season schedule.  Relying on the Ninth Circuit’s decision in Boyd Gaming v. Commissioner from the late 1990s, the court declined, once again, to second guess the team’s business judgment by substituting the government’s own determination.

Although the decision focuses on the specific facts and the exigencies of a traveling hockey team, the decision is of interest for other taxpayers as well.  This is especially true given the IRS’s recent increased interest in both meal deductions and the imposition of payroll tax liabilities with respect to free or discounted meals provided to employees, particularly in company cafeteria settings.  The decision expands the scope of the section 119 exclusion to meals further than the IRS’s current limited view that it applies only to remote work sites, such as oil rigs, schooners,  and camps in Alaska.   To date, the most expansive application of the exclusion in the company cafeteria setting occurred in Boyd Gaming, where a casino successfully established that its policy requiring employees to eat lunch on-site was based on security concerns and the attendant screening procedures made it necessary to provide employees with meals during their shifts.

Jacobs seems to take the analysis one step further, because many of the business reasons for providing meals to Bruins employees could be echoed by other taxpayers.  No doubt, all employers are concerned with the performance of their employees.  To that end, it could be argued that ensuring that they eat well-balanced nutritionally appropriate meals can increase performance even if the employer is more concerned with brains rather than brawn.  Indeed, given the large health insurance costs borne by many employers, employers have a legitimate interest in providing healthy meals that may reduce the incidence of obesity, diabetes, heart disease, and other chronic ailments that raise their costs.  Moreover, many employees have hectic schedules during the work day with frequent appointments, meetings, and other activities that make it necessary to maximize the time available for work during the day.   Given the Tax Court’s implicit admonition of the IRS’s attempt to substitute its own judgment regarding the employer’s business reasoning in Jacobs and the court’s refusal to substitutes its own judgment as well, the IRS likely has a more difficult road ahead if it attempts to challenge the purported business reasons that an employer provides for furnishing meals to its employees.  It remains to be seen how the IRS will react to the decision and whether it will appeal the case, which seems likely.  For now, however, the case is a positive development for employers who have made a business decision to provide meals on a free or discounted basis to their employees to increase productivity and improve their health.

Poor Design and Poor Defense Sink Employee Discount Plan

A recent IRS Field Attorney Advice (FAA) memorandum highlights the risk of poorly designed employee discount plans.  In FAA 20171202F, the IRS Office of Chief Counsel determined that an employer was liable for failing to pay and withhold employment taxes on employee discounts provided under an employee discount plan that failed to satisfy the requirements for qualified employee discounts under Code section 132(c).  The FAA also suggests that had the employer either kept or provided better records of the prices at which it provided services to select groups of customers, the result may have been different.  In the FAA, the IRS applied the fringe benefit exclusion for qualified employee discounts to an employer whose business information was largely redacted.  Under the employee discount program considered, an employee and a set number of participants designated by each employee (including the employee’s family members and friends) were eligible for discounts on certain services provided by the employer.  The Treasury Regulations under section 132(c) permit employers to offer employees and their spouses and dependent children non-taxable discounts of 20 percent on services sold to customers.

The employer argued that, although the discounts provided under the program exceeded the 20 percent limit applicable to discounted services when compared to published rates, they were in most cases less than the discount rates the employer offered to its corporate customers and members of certain programs.   The Treasury Regulations provide that an employee discount is measured against the price at which goods or services are sold to the employer’s customers.  However, if a company sells a significant portion of its goods or services at a discount to discrete customers or consumer groups—at least 35 percent—the discounted price is used to determine the amount of the employee discount.  Despite the employer’s argument that the determination of the amount of the employee discounts should not be based on the published rates, the IRS refused to apply this special discount rule for lack of adequate substantiation.  Although the employer provided the IRS with bar graphs showing the discounts it gave to various customers, the employer did not substantiate the information on the graphs or provide the IRS with evidence showing what percentage of its total sales were made from each of the customers allegedly receiving discounted rates.  Had the employer shown that it sold at least 35 percent of its services at a discount, then at least some, if not most of the employee discounts in excess of the published rates less 20 percent, may not have been taxable.

Having determined that the discounts offered exceeded the 20 percent limit applicable to services, the IRS ruled that the employer must withhold and remit employment taxes on any employee discount to the extent it exceeded 20 percent of the published rate.  Correspondingly, the employer must report the taxable amount as additional wages on the employee’s Form W-2.  Perhaps even more costly for the employer, the IRS determined that the entire value of the discount (and not just the amount in excess of 20 percent) provided to someone designated by an employee constitutes taxable wages paid to the employee unless the person is the employee’s spouse or dependent child.  Accordingly, if an employee designates a friend under the program who uses the discount, the entire discount must be included in the employee’s wages and subjected to appropriate payroll taxation.

Offering employee discounts on property and services sold to customers can make for a valuable employee reward program, but the technical requirements to avoid tax consequences for these programs can be overlooked.  The FAA’s analysis is consistent with the regulations under Code sections 61 and 132, and should not be surprising to anyone familiar with the rules.  Given the recent interest in employee discount programs by IRS examiners conducting employment tax examinations, it would be prudent for employers to review their employee discount programs and consider whether the programs are properly designed to avoid the potentially expensive payroll tax consequences that could be triggered by discounts that do not qualify for the income exclusion under section 132(c).

Bipartisan Support for Legislation Codifying Tax-Free Student Loan Repayment Benefits, But Does the Code Already Allow for It?

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July 25, 2016

As college graduates struggle under the weight of larger student loan burdens, some employers have begun to offer student loan repayment benefits intended to help employees repay their loans.  In May, House Ways and Means Committee member Robert Dold (R-IL) introduced legislation that would, among other changes, amend Section 127 of the Internal Revenue Code to explicitly allow employers to make payments on their employees’ student loans on a tax-free basis.  That provision excludes from gross income up to $5,250 paid by an employer per year for expenses incurred by or on behalf of an employee for education of the employee (including, but not limited to, tuition, fees, and similar payments, books, supplies, and equipment).   Other proposed bills have also been introduced to provide the same benefit.  Although the legislation has bipartisan support, it is unclear whether Congress has the appetite for passing legislation that would appear to reduce revenues, or the fortitude to pass anything nonessential in an election year.

For employers interested in providing tax-free student loan repayment benefits, existing law may already allow for such a result.  The Internal Revenue Service issued a private letter ruling in 2003 that suggests that such payments may already be excludable under Section 127.  In the ruling, a law firm established an educational assistance plan for its non-lawyer employees.  The firm’s employees borrowed funds to pay for law school.  The firm then provided the employees with additional salary to pay the principal and interest due on the loans during each year of employment, essentially forgiving the debt.  The IRS ruled that the first $5,250 of loan payments each year were excludable from the employee’s income under Section 127.  Although the private letter ruling applies only to the taxpayer and does not fully describe the terms of the law firm’s program, it offers a strategy for employers to consider when evaluating how to help their employees with student loan payments.

Wellness Program Cash Rewards and Salary-Reduction Premium Reimbursements Taxable

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May 27, 2016

Recently, the IRS clarified whether employees are taxed for receiving cash rewards and reimbursements from their employers for participating in wellness programs.  In CCA 201622031, the IRS ruled that an employee must include in gross income (1) employer-provided cash rewards and non-medical care benefits for participating in a wellness program and (2) reimbursements of premiums for participating in a wellness program if the premiums were originally made by salary reduction through a Section 125 cafeteria plan.

In CCA 201622031, the taxpayer inquired whether an employee’s income includes (a) employer-provided cash rewards or non-medical care benefits, such as gym membership fees, for participating in a wellness program; and (b) reimbursements of premiums for participating in a wellness program if the premiums were originally made by salary reduction through a cafeteria plan.  The IRS ruled that Sections 105 and 106 do not apply to these rewards and reimbursements, which are includible in the employee’s gross income and are also subject to employment taxation.

Limitations on Cash Reimbursements for Transit Benefits Apply to Retroactive Increase in Transit Limits

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March 2, 2016

In a technical advice memorandum (PMTA 2016-01), the IRS Office of Chief Counsel stated that a retroactive increase in transit benefits paid in a cash lump sum is only excludable to the extent a transit pass or voucher is unavailable.  This ruling clarifies that these retroactive increases are subject to the same rules as other transit benefits.  This issue arises from Congress’s decision to increase the amount of transit benefits excludable from income in 2012, 2014, and 2015 (e.g., the limit in 2015 was increased from $130/month to $250/month), which has led employers to inquire about the tax treatment of lump sum payments made to compensate employees for transit payments made by the employees in those years that exceeded the limits in place at the time.  The IRS states that it will deem such lump sum payments income and subject to withholding and reporting if transit passes or vouchers are “readily available.”

If transit passes or vouchers are not “readily available,” employers may provide cash reimbursements, so long as employees incur and substantiate their expenses pursuant to an accountable plan.  Accordingly, most employers are unable to allow employees to take advantage of the retroactive increase.  If an employer allowed employees to exceed the pre-tax limit and purchase transit passes with after-tax dollars (or provided the employees with transit passes and imputed taxable income for amounts in excess of the pre-tax limit), it could provide amended Forms W-2 and file Forms 941-X removing the after-tax amounts from wages (for both FITW and FICA purposes).  However, given that the difference for each employee is only $1450 per year, some employees may not wish to file amended income tax returns to recover any excess tax paid.  In addition, the cost savings for employers may not be sufficient to justify the expense of preparing the amended returns.