Sec 3: Taxable and Nontaxable Compensation Flashcards
Gross Income and Wages Under the IRC
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Gross Income
The IRC uses the term “gross income” as the starting point for determining a taxpayer’s federal tax bill, and in it broadly defines the term as including “compensation for services, including fees, commissions, fringe benefits, and similar items
Wages and Benefits
What this means is that wages and benefits (whether they are called fringe benefits or “perks” or something else) are generally included in income and subject to income and employment tax withholding, deposit, and reporting requirements unless the IRC says otherwise. The Code does not define the term “fringe benefit,” though the Code
and the IRS Regulations include several examples of both included and excluded fringe benefits:
Examples
- Employer- provided cars
- Flights on employer- provided aircraft
- Free or discounted commercial flights
- Vacations
- Discounts on property or services
- Employer- paid memberships in country clubs or other social clubs
- Tickets to entertainment or sporting events
- Qualified tuition reductions
- Dependent care assistance
- No- additional- cost services
- Working condition fringes
- Qualified transportation fringes
- De minimis fringes
Income and Employment Taxes Defined
In general, when employee compensation is described as “taxable,” this means:
* It is subject to federal income tax and the employer must withhold the tax from the employee’s pay and remit it to the Internal Revenue Service.
* It is subject to social security and Medicare taxes under the Federal Insurance Contributions Act (FICA), as well as federal unemployment tax under the Federal Unemployment Tax Act (FUTA)— these taxes are often referred to as employment taxes.
Fair Market Value
When noncash fringe benefits or “perks” are provided by an employer to its employees, the amount of the benefit is defined as its fair market value, or what it would cost an individual to purchase the benefit on the open market in an “arm’s length transaction
IFBA = FMV – (EPA + AEL)
IFBA = Includable Fringe Benefit Amount
FMV = Fair Market Value
EPA = Employee- Paid Amount (with after- tax dollars)
AEL = Amount Excluded by Law
Example 1: Harry’s employer pays for Harry’s parking space in a commercial parking lot next to the employ- er’s premises. The employer’s cost for the space is $350 per month in 2024, which is the same fee charged to all monthly payers. Harry pays nothing for the parking space and has access to it every day. Up to $315 per month of employer-provided parking is excluded from income by law in 2024 (see Section 3.2-1). Harry’s taxable income from the parking benefit is determined as follows:
IFBA = $350 – ($0 + $315)
IFBA = $350 – $315
IFBA = $35 per month
Nontaxable Fringe Benefits
- No-additional-cost services
- Qualified employee discounts
- Working condition fringes
- De minimis fringes
- Qualified transportation benefits
- On-premises athletic facilities
- Qualified retirement planning services
No‑additional‑cost services
No‑additional‑cost services. An employer may offer free services to its employees without including the fair market value of those services in the employees’ income if the following conditions are met:
- The free service is one that is regularly offered for sale to customers (not employees) in the normal course of the employer’s “line of business” in which the employee works. There is an exception where companies have written “reciprocal agreements” providing free services to employees of the other employer covered by the agreement and neither employer incurs substantial additional cost in providing the benefit.
- The employer bears no substantial additional cost (including lost revenue and additional labor) in provid- ing the service to the employee.
- The term employee includes current and former employees who left because of retirement or disability and their widow(er)s, spouses, and dependent children. For the purposes of air transportation, the term employee also includes a parent of an employee.
- The service is available on equal terms to each member of a group of employees whose classification does not discriminate in favor of highly compensated employees.
Qualified employee discounts
n employer may offer discounted goods or services to its employees without
adding the fair market value of the discounts to the employees’ income if the following conditions are met:
- The discount on goods cannot exceed the gross profit percentage when the goods are sold to customers (not employees). The gross profit percentage is: (total sales – cost of goods sold) ÷ total sales
- The discount on services cannot exceed 20% of the price at which the services are offered to customers. If the discount exceeds 20%, the excess is taxable income to the employee.
- The goods or services must be offered for sale to customers in the employer’s line of business in which the employee normally works.
- The discount is available on equal terms to each member of a group of employees whose classification does not discriminate in favor of highly compensated employees (for a definition, see the discussion earlier in this section on no-additional-cost fringes).
- Real estate, whether for investment purposes or not, does not qualify for the employee discount. Neither does personal property normally held for investment, such as stocks, bonds, or currency.
- The term employee includes current and former employees who left because of retirement or disability and their widow(er)s, spouses, and dependent children.
Working condition fringes
Working condition fringes. An employer may offer certain work-related property or services to employees without including their fair market value in the employees’ income if the following conditions are met:
- The employee’s use of the property or services must relate to the employer’s trade or business.
- The employee would be able to take a business deduction on his or her personal tax return if the employee paid for the benefit (but see exception for reimbursements of business-related club dues and spousal travel expenses).
- The term “employee” means a current employee, partner, director, or independent contractor performing services for the employer.
- The employer must maintain the required records to substantiate the business deductions. Where the benefit is in the form of cash, the employer must require beforehand that the payment be used for a business activity, that the employee verify that the payment was used for that purpose, and that any excess be returned to the employer within a reasonable period of time.
De minimis fringes
De minimis fringes. An employer may provide certain property or services of small value to employees without including the value in the employees’ income if the following conditions are met:
- The value of the benefit is so small that accounting for it would be unreasonable or impracticable.
- The employer must take into account the frequency with which it provides the benefit to all its employees in making this determination.
- The term employee means anyone to whom the benefit is provided.
Qualified transportation fringes
Qualified transportation fringes. An employer may provide certain transportation fringe benefits to its employees without including the fair market value of the benefits in their income. They include:
- Transportation between home and work in a commuter highway vehicle provided by the employer (e.g., vanpool) if:
* The vehicle seats at least 6 adults other than the driver
* At least 80% of the vehicle’s mileage can be expected to be for commuting
* At least one-half of the vehicle’s seating capacity (excluding the driver) is used by employees
The excluded benefit is limited to a value of $315 per month in 2024.
- Transit passes, vouchers, tokens, or fare cards, or reimbursement for them by the employer, for up to $315 per month in 2024.
- Parking provided on or near the employer’s premises or at a “park and ride” facility from which the employee uses mass transportation, a vanpool, or a carpool or any other means to get to work, up to a value of $315 per month in 2024. Parking “on or near the employer’s premises” includes parking on or near a work location where the employee works for the employer, but not if the value of parking provided by the employer or reimbursement for the employee’s parking cost is otherwise excluded from income as a working condition fringe benefit or an employee business expense reimbursed under an accountable plan.
On‑ premises athletic facilities
On‑premises athletic facilities. An employer may allow its employees to use an on-premises gym or other athletic facility free of charge without including the fair market value of the use in the employees’ income if the following conditions are met:
- The athletic facility is located on the employer’s premises, whether leased or owned by the employer.
- The athletic facility is operated by the employer through its employees or another entity.
- Substantially all use of the athletic facility is by employees, their spouses, and their dependent children.
The term employee includes current and former employees who left because of retirement or disability, as well as their widow(er)s. - The athletic facility is not a resort or other residential facility.
