Nontaxable employee fringe benefits - No additional cost services

Despite recent Congressional attempts to close loopholes and raise revenues, provisions in the Tax Code still exist that allow employers to provide and deduct certain fringe benefits that are likewise not included in the employee's income. For the small, closely-held corporation, where owners often time make up the majority of the employees, this means an ability to deduct the cost of products or services that ordinarily would be "personal" in nature. For the larger business, goodwill among employees can be enhanced by offering such tax deductible fringe benefits. In addition, fringe benefits are excluded from an employee's wage base for computing tax withholding, FICA, FUTA, and RRTA. The following are examples of fringe benefits that are deductible by the employer and not included in the employee's income:

No Additional Cost Services are provided by an employer to an employee for use by such employee if (1) such service is offered for sale to the employer's customers in the ordinary course of the line of business in which the employee works, and (2) the employer incurs no substantial additional cost (including forgone revenue) in providing such service to the employee (determined without regard to any amount paid by the employee).

Only "excess capacity" services qualify under this fringe benefit rule. Excess capacity services include (but are not limited to) hotel accommodations; transportation by aircraft, train, bus, subway, or cruise line; and telephone services. Non-excess capacity services which would not be excludable by the employee because the employer incurs substantial additional cost in providing the service would include legal, accounting, and other similar services.

In addition, an excess capacity service must be in the same or similar line of business in which the employee regularly performs. I.R.C. § 132(b)(1). This rule prevents, for example, a conglomerate employer owning an airline and hotel from offering free hotel services to its airline employees.

No additional cost services may be made available by one employer to an employee of another employer and still qualify as a tax-free fringe benefit provided that (a) both employers furnish the same type of service to the nonemployee, (b) the employers have written reciprocal agreements that allow employees from both employers to benefit from the other's services, and (c) neither employer incurs substantial additional cost in providing such services. An example would be competing airlines offering free standby flights to the other's employees. The following example demonstrates the reciprocal arrangement:

Example:  An employee of airline X receives free standby flights from airline Y under a written reciprocal agreement between X and Y. The value of such standby flights can be excluded from the recipient's income if it would have been excluded as a no-additional-cost service if it had been provided in the same manner by X. Thus, the free flights furnished by Y must be available to the employees of X on the same nondiscriminatory basis as required for the exclusion when furnished by X and neither employer may incur any substantial cost (including foregone revenue or any payment from one employer to the other), either in providing the service or under the agreement.

- David Repp

The material in this blog is not intended, nor should it be construed or relied upon, as legal advice. Please consult with an attorney if specific legal information is needed.