By Kathy Mitts and Ryan Newkirk
Did you know that your tax exempt status does not extend to fringe benefits provided to your employees?
The flurry of recent IRS examinations of non-profit and governmental entities has brought the issue of the taxability of fringe benefits offered to employees to center stage. It remains unclear if the entities under IRS exam were unaware of the taxability of these benefits or if they did not have systems in place to capture the data. This article will attempt to raise your awareness of the proper tax treatment of some of the most common fringe benefits being provided by governmental and non-profit entities.
In one case a county was found to have spent $1.5 million for employee perks such as cars, cell phones and uniforms without taxing them. The county (not the employees) was assessed the tax deficiency of $500,000. Ouch!
Before we look at the most common fringe benefits, let’s understand what we mean by fringe benefits.
Understanding Fringe Benefits
The term “fringe benefit” is not defined in the Internal Revenue Code or its regulations. For lack of a defined term a “fringe benefit” is any item of additional benefit or compensation that should be included in gross income unless otherwise excluded by a section of the Internal Revenue Code. The vagueness left open by the Internal Revenue Service makes it very difficult for those not well versed in this area to ensure the proper treatment of fringe benefits. While not all fringe benefits are taxable, a taxable fringe benefit is included in the income of the employee performing the services in connection with which the fringe benefit is furnished. IRC Section 61.
Taxable fringe benefits include but are not limited to:
- An employer provided automobile, which includes personal use
- An employer provided membership in a country club or other social club
- Includable meals (not reimbursed)
- An employer provided vacation
- Certain uniform and clothing allowances
- Per diem allowances in excess of substantiated expenses
Excludable (not taxable) fringe benefits include but are not limited to:
- Benefits provided under a dependent care assistance program (subject to limitations)
- Working condition fringe benefits like subscriptions to appropriate journals, coffee, donuts, etc.
- Employee Achievement Awards for safety or length of service (not cash) with limits
- Qualified moving expense reimbursement
- Qualified employee discounts
- Qualified transportation fringe
- De minimis fringe benefits, includes cell phones now
The IRS rules and limitations vary for each type of fringe benefit. The IRS rules for the most common fringe benefits used by non-profit and governmental entities are provided below.
Employer Provided Vehicles
When an employer provides an employee with the use of an employer owned vehicle, the employee receives a fringe benefit which is includible in gross income. The amount includible in the employee’s income is the value of the personal use of the vehicle. There are three methods available as alternatives to value the personal use of employer provided vehicles:
- The annual lease value method
- The cents per mile method, and
- The commuting value method.
The annual lease value method may be used only to value employee use of an employer-provided automobile (4 wheeled vehicle). The cents per mile and commuting value methods may be used for all employer-provided vehicles (any motorized vehicle – includes automobile). Reg. 1.61-21(d)(1)(i), Reg. 1.61-21(e)(2).
Meals or Lodging for the Convenience of the Employer
Meals and lodging furnished to an employee, his spouse, and his dependents shall be excluded from gross income if it is provided by the employer for the convenience of the employer (for a custodian, etc), but only if:
- In the case of meals, the meals are furnished on the business premises of the employer, or
- In the case of lodging, the employee is required to accept such lodging on the business premises of his employer as a condition of his employment. IRC Section 119.
The value of meals and lodging not occurring on the business premises will be included in compensation of the employee and taxed accordingly.
Employer Provided Uniforms
If an employer mandates that employees wear uniforms while performing their duties, the cost of uniform is not taxable to the employee if such clothing is necessary for the job and not suitable for everyday wear (police uniform, etc.). Mandated uniforms, such as a police officer or public works employees that are provided by the employer and are a condition of employment, would not be taxable as a fringe benefit to the employee. If uniforms are not mandated to be worn and provided by the employer as a benefit to the employee, the cost of the uniform must be included in the employee’s gross income. If the employer provides an allowance to the employee to cover uniform expenses the inclusion in income is based on the determination if the allowance is a working condition fringe benefit. This means the expense would be deductible by the employee had he not received an allowance. If the allowance is considered a working condition fringe benefit the allowance is not included in the employee’s income. IRC Section 132(a)(3).
Recent IRS pronouncements has removed cell phones from the “listed property” category and moved them to the de minimis fringe benefit category making their taxability no longer in question. P.L. 111-240. Prior to this change in the law employees had to keep track of their personal usage of the employer provided cell phone. Their personal usage was then includable in gross income as a taxable fringe.
Accountable Plan or Non-Accountable Plan
Employers have the option for employee expense reimbursements for Lodging, Meals & Incidental expenses (M&IE) of offering an accountable plan or a non-accountable plan. Under an accountable plan all business expenses incurred by the employee must be accounted for to the employer and any excess advance must be timely repaid to the employer. An accountable plan provides tax free reimbursement of business expenses as long as the accounting to the employer is done. Under a non-accountable plan there is no requirement to account to the employer for any expense or return any excess and all dollars received by the employee are taxable.
Per Diem Allowance
If an employer pays a per diem or mileage allowance under an arrangement that otherwise qualifies as an accountable plan, the portion of the allowance paid that relates to properly substantiated days or miles of travel, but that exceeds the amount of the employee’s expenses deemed substantiated for such travel under any of the standard per diems mileage methods is treated as paid under a non-accountable plan. Only the amounts treated as paid under an accountable plan are excluded from employee’s gross income. However, amounts treated as paid under a non-accountable plan are included in the employee’s gross income. Reg 1.62-2(h)(2)(i)(B).
We Can Help
It is easy to see how confusion can set in when contemplating the taxability fringe benefits. There are many other types of fringe benefits beyond the scope of this article. We are happy to discuss the taxability of your fringe benefit offerings to help you avoid conflict with the IRS and an unnecessary tax payment.
Kathy Mitts, CPA
Managing Principal, Cincinnati Office
Chris Flaig, CPA
Principal in Charge of Assurance Services, Cincinnati Office
View the IRS Taxable Fringe Benefit Guide