Qualified employee discounts for property - some technical aspects.

• Author: Weld, Leonard G.

Employee discounts are an everyday occurrence. Companies use them to build employee goodwill and sometimes to reduce inventory pilferage. The discount allowed by a company on the goods sold to an employee is specifically exempted from the employee's gross income by Sec. 132(c), as long as certain criteria are met. Two of the more technical aspects of employee discounts involve who is considered an employee and the determination of amounts used in the discount calculation.

Sec. 132(c)(3) defines an employee discount as the excess of the sales price to customers over the sales price to employees. Sec. 132(c)(1) defines a qualified employee discount as a discount on qualifying property to the extent it does not exceed the gross profit percentage multiplied by the price at which the property is being offered to customers. The gross profit percentage is determined on the basis of (1) all property offered to customers in the ordinary line of business in which the employee works and (2) the employer's experience over a representative period of time. Regs. Sec. 1.132-3(b)(2)(iv) states that the representative period is normally the tax year immediately preceding the tax year in which the property is sold.

Employees

The first important issue is who qualifies as an employee. Partners and greater-than-2% S shareholders are considered employees. Only Sec. 132(f)(5)(E)--pertaining to transportation fringe benefits--excludes the self-employed, partners and greater-than-2% S corporation shareholders from receiving qualified fringe benefits on a taxfree basis. However, the partner or shareholder must actually be an employee providing services to the business in order to qualify for the discount. This criterion excludes directors, customers and independent contractors.

Extended definition of employee: Sec. 132(h) expands the definition of employee to include individuals who do not work for the company offering the discount. Also included are former employees who separated from service because of retirement or disability, and the widows or widowers of any individuals who died while employed. In addition, any use of the discount by a spouse, dependent child or stepchild is treated as use by the employee.

There is a reciprocal agreement exception for no-additional-cost services, so that among agreeing employers any employee of the agreeing parties is considered an employee of all employers (Sec. 132(i)). However, no such exception is allowed for employee...