Nonstatutory Fringe Benefits

There is a special category of fringe benefits that you may provide to your employees on a tax-deductible basis but which your employees need not include in their income. These are referred to as nonstatutory fringe benefits because there is no separate section in the Internal Revenue Code for each particular benefit—they are all covered in the same section. Nonstatutory fringe benefits are not only excludable from the employee’s gross income; they are also not subject to employment taxes. In general, these benefits must be provided on a nondiscriminatory basis. Benefits cannot be provided solely to owners and highly paid employees and not to rank-and-file employees. Nonstatutory fringe benefits include:

• No-additional-cost service. You need not include in your employee’s gross income the value of a service you offer to customers in the ordinary course of the business in which your employee works (e.g., if you run a ferry line and allow employees to ride for free on scheduled runs). In the case of no-additional-cost service, you generally do not have any expense to deduct by virtue of providing the benefit to the employee. You have already deducted costs related to providing the service.
• Qualified employee discount. You need not include in your employee’s gross income a price reduction you give on certain property or services you offer to customers in the ordinary course of your business in which the employee performs services (e.g., if you own a clothing boutique and give your salespersons a 15% discount on your merchandise). A qualified employee discount cannot exceed the price at which the item is ordinarily sold to customers multiplied by your gross profit percent (total sales price of property less cost of property, divided by total sales price of property) or 20% in the case of services.
  A qualified employee discount does not include any discount on real property. A deduction for the goods or services provided as a qualified employee discount is not taken into account as a compensation expense but rather as some other item. Goods provided to employees at a discount are part of the cost of goods sold.
• Working condition fringe benefit. You need not include in your employee’s gross income a benefit provided to your employee if the employee could have claimed his or her own deduction had he or she paid for the benefit. For example, if you paid for a job-related course that would have been deductible by your employee had the employee paid for it, the course is a working condition fringe benefit. Other examples of working condition fringe benefits include employer-provided vehicles and outplacement services.
• De minimis (minimal) fringe. You need not include in your employee’s gross income the value of any small or inconsequential benefits, such as the typing of a personal letter by a company secretary or the occasional use of the company copying machine for personal matters. Holiday gifts of nominal value, such as turkeys and hams, are considered de minimis fringes. However, cash of any amount is not a de minimis fringe and must be included in the employee’s gross income. Other examples of de minimis fringes include group term life insurance for spouses and dependents up to $2,000, meals furnished at an eating facility on or near your premises, coffee or soft drinks furnished to employees, flowers or fruit baskets for special occasions, occasional tickets to sporting or entertainment events, occasional meal money or transportation fare for employees working overtime, and company events (such as parties or picnics) for employees and their guests.
• Qualified transportation fringe benefit. If you provide your employee with a transit pass for mass transit, transportation in a commuter highway vehicle, or qualified parking, you need not include the benefit in your employee’s gross income. The 2012 limit on this exclusion for free parking is $240 per month and for mass transit and van pooling, it is $125 per month (unless parity is re-established for parking and transit passes). The value of parking is based on what a person would have to pay for space in an arm’s-length transaction. If you provide parking space to employees that is primarily available to customers, then the parking has no value. If you give employees who carpool preferential parking, the value of the space must be taken into consideration. Employer-paid parking at a temporary job assignment—one expected to last 1 year or less that does in fact last that period—is fully excludable as paid under an accountable plan (explained in Chapter 8); there is no dollar limit in this situation. If the dollar limits are exceeded, only the excess is includible in gross income. However, in the case of partners, LLC members, and more-than-2% S corporation shareholders who are given public transit passes, the exclusion is limited to $21 per month. If the value of this exceeds the $21 per month limit, then the entire cost of the ticket is includible in the owner’s gross income. The entire value of parking provided to partners and more-than-2% S corporation shareholders is taxable to them, even if it is less than $240 per month. There is another transportation fringe benefit for bicycle commuting of $20 per month to cover the cost of buying, maintaining, and storing a bicycle used to get to and from work. You can shift the cost of monthly transit passes to employees—they pay for the passes by means of salary reductions (i.e., pretax dollars); all you pay for is the administrative cost of handling the benefit. The fact that you offer an employee a choice between a qualified transportation fringe benefit and cash does not make the benefit taxable if the employee chooses the benefit. The employee is, of course, taxed on cash received in lieu of the transportation fringe benefit.

• Moving expenses. Payments to an employee (directly to the mover or as an allowance) for nondeductible moving expenses are deductible as wages and subject to employment taxes. Payments or reimbursements that would be deductible by the employee had the employee paid them are not treated as wages and are not subject to employment taxes. They are still deductible by you as noncompensatory business expenses. Moving expenses are explained further in Chapter 22.
• Certain athletic facilities. You need not include in your employee’s gross income the value of an on-site gym or other athletic facilities for use by employees, their spouses, and children. However, if you pay for a membership to an outside health club or athletic facility open to the general public, you must include the benefit in the employee’s gross income. No deduction can be claimed for club dues (see Chapter 8).

Some companies allow employees to use business-generated frequent flyer mileage for personal purposes. This benefit defies classification and, to date, the IRS has not figured out a way to tax it without causing an administrative nightmare.

Limits on fringe benefits paid for the benefit of sole proprietors, partners, LLC members, and more-than-2% S corporation shareholders that are otherwise excludable by rank-and-file employees are taxable to sole proprietors, partners, LLC members, and more-than-2% S corporation shareholders. For example, if the business pays their health insurance (which may include long-term care insurance), the coverage is taxable to them. The business can deduct the costs as guaranteed payments to partners or as compensation to S corporation shareholders. Owners can then deduct the amount directly from gross income on page 1 of Form 1040.

The balance can be treated as a deductible medical expense, which is taken as an itemized deduction subject to a 7.5% floor. Medical coverage for these owners is discussed in Chapter 19.

If, in 2012, the business provides qualified parking, the benefit is taxable to the sole proprietor, partner, LLC member, or 2% S shareholder even though its value is less than $240 per month.