Nontaxable fringe benefits: made more valuable by the Revenue Reconciliation Act of 1993.

• Author: Weld, Leonard G.

The 36% and 39.6% tax brackets added by the Revenue Reconciliation Act of 1993 can make a nontaxable fringe benefit worth considerably more to both the employee and the employer than cash wages. For example, assuming a $1,000 wage and 36% Federal, 5% state and 7.65% FICA tax rates, an employee will take home only $513.50 (51.35% X $1,000). Even if the employee's wages are in excess of the Social Security wage base ($61,200 in 1995), all wages are now subject to the Medicare portion of FICA (1.45%).

Nontaxable fringe benefits can provide an advantage over cash wages for the employer, too. The employer is allowed a deduction for the payment of wages and for most fringe benefits furnished to the employee. The advantage for the employer is that by providing fringe benefits that are not included in an employee's gross income, the employer is relieved of paying the matching FICA contribution. For a large employer, the savings accumulate quickly. If, for example, a $1,000 nontaxable fringe benefit is provided to 200 employees, the total FICA matching may be as much as $15,300 ($1,000 X 200 X 7.65%). In addition, some fringe benefits cost the employer less than their value to the employee (e.g., parking on the employer's premises, meals and lodging).

This article examines several popular noncash fringe benefits--employee achievement awards, group-term life insurance, employee meals, transportation, moving expenses and education--and provides guidance on how to ensure that the value of the benefit is excluded from the employee's income.(1) The table on page 501 provides a summary of the important points for each of the benefits discussed.

Gross Income

Under Sec. 61, gross income includes all income from whatever source derived. Unless the taxpayer can specifically identify a Code section that allows an exclusion, all value received is included in income. Sec. 102(a) excludes gifts, bequests and inheritances from gross income, but amounts transferred from an employer to an employee are not excluded, under Sec. 102(c).(2) Therefore, employers wishing to provide a tax-free benefit to employees must do so outside of the format of a gift.

Most tax-free noncash benefits have discrimination provisions associated with them. If the provision of the benefit by the employer discriminates in favor of a prohibited class of employees (e.g., highly compensated employees (HCEs), as defined in Sec. 414(q)), the value of the benefit is taxable to the favored employees. The Code identifies who is an employee for purposes of each benefit. The glossary on page 495 provides some key definitions in determining who is an employee and who is a member of a discriminatory group.

Noncash Fringe Benefits

* Employee achievement awards

Sec. 74(c) provides an exclusion from income for employee achievement awards. The value of a qualifying award is excluded from income by the employee as long as the cost of the award does not exceed the employer's deduction under Sec. 274(j). Under Sec. 274(j)(2), the maximum annual deduction is $400 per employee if the award is made under a nonqualified award plan and $1,600 if made under a qualified plan. Sec. 274(j)(2)(B) bars aggregating the amounts to deduct $2,000 in awards to a single employee.

For this purpose, a qualified plan is a written plan or program that does not (1) discriminate in favor of HCEs as to eligibility or benefits or (2) provide awards with an average cost in excess of $400 (without taking into account awards of only nominal value). Prop. Regs. Sec. 1.274-8(c)(5)(ii) states that an award costing $50 or less is nominal.

To ensure that bonuses are not disguised as employee achievement awards, Sec. 274(j)(3) defines a qualifying award as meeting all of the following:

1. An item of tangible personal property transferred to an employee for a length-of-service or safety achievement.

2. Awarded as part of a meaningful presentation.

3. Awarded under conditions and circumstances that do not create a significant likelihood of the payment of disguised compensation. Under Prop. Regs. Sec. 1.274-8(c)(2), "tangible personal property" does not include cash, negotiable gift certificates, vacations, meals, lodging, tickets to theater and sporting events, stocks, bonds and other securities.

   If the cost or fair market value (FMV) of the award exceeds the $400 (or $1,600) allowed, the excess is included in the employee's income under Sec. 74(c).

   Example 1: Under a qualifying plan, an employer makes a length-of-service award in the form of a large-screen television set to an employee. The cost of the television set to the employer is $1,450 and its FMV is $1,775. The amount excluded by the employee is $1,775. Because the cost to the employer ($1,450) is less than the allowable deduction amount ($1,600) and is fully deductible, the FMV of the award is excluded from the employee's income.

   Example 2: Under a qualifying plan, an employer makes a safety achievement award in the form of a pearl necklace to an employee. The cost of the necklace to the employer is $1,635 and its FMV is $1,670. The deduction to the employer is $1,600, the cost of the necklace as limited by Sec. 274(j)(2)(B). Under Sec. 74(c)(2), the amount included by the employee in income is the greater of (1) $35 (the difference between the cost, $1,635, and the allowable deduction, $1,600), or (2) $70 (the difference between the FMV, $1,670, and the deduction, $1,600). Thus, the employee includes $70 in income.

   Example 3: The facts are the same as in Example 2, except that the FMV of the necklace is $2,900. Under these circumstances, Regs. Sec. 1.274-8(c)(4) indicates that the FMV is so disproportionate to the employer's cost of the item that it will be considered payment of disguised compensation. As a result, no portion of the award qualifies as an employee achievement award, and the FMV of the award is compensation subject to withholding.

   The employer's advantage in establishing a qualified plan is that the deductible amount can exceed $400. Without the qualified plan in Example 1, only $400 of the cost of the television set would be deductible and the IRS could raise the issue of hidden compensation. The qualified plan increases the deductible amount to $1,600 and avoids the compensation issue for awards up to that amount. To retain qualified plan award status, the employer should time the purchase of gifts to ensure that the average cost of all awards provided per tax year does not exceed the $400 limit of Sec. 274(j)(3)(B)(ii).

   * De minimis gifts

   Sec. 274(b) allows employers to give de minimis business gifts and to deduct the cost up to $25 per employee; the employee need not include such a gift in income. A written achievement award plan is not needed.

   * Group-term life insurance

   Sec. 79(a) excludes from income the cost of the first $50,000 of group-term life insurance provided by an employer to an employee. The cost of any additional life insurance provided by the employer to the employee is includible in the employee's income; such cost is determined under Regs. Sec. 1.79-3(d)(2), Table I, then reduced by any employee contributions.

   To qualify as group-term life insurance under Regs. Sec. 1.79-1(a), the insurance plan must meet all of the following conditions:

   * Provide a general death benefit excludible from gross income under Sec. 101(a).

   * Be provided to a group of employees (at least 10, according to Regs. Sec. 1.79-1(c)).

   * Be provided under a policy carried directly or indirectly by the employer.

   * Compute the amount of insurance provided to each employee under a formula that precludes individual selection.

   Because insurance coverage must be based on the employment relationship, the exclusion does not apply to insurance provided to a director, stockholder, owner or partner. However, Regs. Sec. 1.79-0 provides that a former employee who performs service for a company as an independent contractor qualifies because of the prior service.

   The insurance policy is considered "carried" by the employer under that regulation if (1) the employer pays any part of the cost of the life insurance directly or indirectly or (2) the employer (or two or more employers) arranges for payment of the cost of the...