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.