Top Tips for Helping Business Owners Navigate Payroll, 1099, and Other Human Resources Issues

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1 THE ALL-STAR TAX SERIES SPONSORED BY EDWARD JONES presents Top Tips for Helping Business Owners Navigate Payroll, 1099, and Other Human Resources Issues CPE Broadcast Date: Nov. 4, 2015

2 NPHR 15/01 Upcoming CPE Broadcasts: Wednesday, November 18, 2015: Individual Tax Update Wednesday, December 9, 2015: Tax Update for Small and Medium-sized Businesses and Their Owners Wednesday, January 13, 2016: Getting Ready for Busy Season: New IRS Forms and Compliance Requirements Register online at Questions? Call (610) This product is intended to serve solely as an aid in continuing professional education. Due to the constantly changing nature of the subject of the materials, this product is not appropriate to serve as the sole resource for any tax and accounting opinion or return position, and must be supplemented for such purposes with other current authoritative materials. The information in this manual has been carefully compiled from sources believed to be reliable, but its accuracy is not guaranteed. In addition, All-Star Tax Series, LLC, its authors, and instructors are not engaged in rendering legal, accounting, or other professional services and will not be held liable for any actions or suits based on this manual or comments made during any presentation. If legal advice or other expert assistance is required, seek the services of a competent professional. Materials provided to Edward Jones by All-Star Tax Series, LLC. Opinions and positions stated in this material are those of the authors and do not represent the opinions or positions of Edward Jones. Copyright 2015 All-Star Tax Series, LLC cpenow.com / [email protected] i NPHR/15/01

3 Table of Contents Tax Update Introduction 1 I. Employee versus independent contractor 2 A. Revenue Ruling (The 20 Factors) 2 1. Behavioral control 3 2. Financial control 3 3. Relationship of the parties 4 4. Form SS-8 5 B. Form C. Officers 6 D. Misclassification of workers 6 1. Section 530 Relief requirements 6 2. Section Reasonable basis 7 E. Form SS-8 7 F. Voluntary Classification Settlement Program 8 G. Retirement plan failures resulting from a worker reclassification 11 H. Department of Labor s Administrator s Interpretation No II. New overtime proposals from the Department of Labor 12 A. Introduction to the Fair Labor Standards Act Executive employee exemption Administrative employee exemption Learned professional exemption Creative professional employee exemption Computer employee exemption Outside sales exemption Highly compensated employees exemption Treatment of blue collar workers Police and other first responders 14 B. FLSA Administrative standards Stormy weather 15 C. Proposed changes 16 D. Home Care Association of America v. Weil 17 III. Affordable Care Act implications of worker status classification 18 A. Application of controlled group and affiliated group rules 18 IV. Tax schedules and Form A. Who must file Form 1099-MISC? 19 B. Trade or business reporting only 19 C. Exceptions from Form 1099 filing 19 D. Form 1099-MISC filing requirements for landlords 20 E. New penalty regime for 2016 and after 20 F. Form 1099 reporting 21 V. Affordable Care Act information reporting 22 VI. Entity selection and fringe benefits 23 A. Retirement plans 23 VII. Health insurance and the Affordable Care Act 23 A. Notice B. Small employer transition relief 25 C. Subchapter S Arrangements 25 D. Tricare Arrangements 26 E. After-tax Arrangements 26 F. Anti-discrimination rules under 105(h) 26 G. Highly compensated individuals for 105(h) purposes 27 H. Anti-discrimination tests Section 105(h) penalties 28 I. ERISA and the Fair Labor Standards Act Fair Labor Standards Act 18C 29 VIII. Accountable plans 30 cpenow.com / [email protected] ii NPHR/15/01

4 A. How employees comply with accountable plan rules 30 B. Consequences of not complying with accountable plan rules 30 C. Nonaccountable plans 31 D. Reporting employee expenses under a nonaccountable plan 31 IX. Form W-2 reporting under the ACA 32 A. Transition relief from W-2 reporting 33 B. Limits on out-of-pocket caps 33 C. Notification of Health Insurance Marketplace 33 X. Cafeteria plans 34 A. Nondiscrimination requirements 36 B. Flexible spending accounts 36 XI. Tax treatment of selected fringe benefits 38 A. Athletic facility 38 B. Athletic skyboxes/cultural entertainment suites 39 C. Awards and bonuses 39 D. Employee achievement awards 39 E. Dependent care assistance 40 F. Health savings accounts 41 G. Club memberships 42 H. Business credit cards 43 I. Executive dining room 43 J. Moving expense reimbursements 44 K. No-additional-cost services 45 L. Retirement planning services 47 M. De minimis transportation benefits 47 N. Tuition reduction 49 O. Working condition benefits Employer-provided vehicles Education provided by an employer Educational assistance Outplacement services 53 P. Employer-provided auto 54 Q. Group-term life insurance Spousal/dependent life insurance 62 R. Employee stock options 62 S. Loans to employees 62 T. Qualified employee discounts 64 U. Security-related transportation 65 V. Employer-provided meals 66 cpenow.com / [email protected] iii NPHR/15/01

5 Tax Update Broadcast Date: November 4, 2015 Copyright 2015 All-Star Tax Series, LLC

6 2016 Pension Plan Contribution Limits IRS News Release IR IRS cost-of-living adjustments to pension plans for 2016 most limits remain the same for 2016 Benefit limit for DB plans remains at $210,000 DC plan limit remains at $53,000 Limit on contributions to SIMPLE accounts remains at $12,500

7 2016 Pension Plan Contribution Limits IRS News Release IR Compensation limit for determining benefits and contributions remains at $265,000 Definition of a highly-compensated employee remains at $120,000 Elective deferral limit for employees participating in 401(k), 403(b), and most 457 plans remains at $18,000 (catch-up is $6,000)

8 Rev. Proc AMT Exemption Amounts for 2016 Joint Returns or Surviving Spouse $83,800 Unmarried Individuals $53,900 Married Filing Separate $41,900 Estates and Trusts $23,900

9 Rev. Proc Standard Deduction for 2016 Joint Returns or Surviving Spouse $12,600 Heads of Households $ 9,300 Unmarried Individuals $ 6,300 Married Filing Separate $ 6,300

10 Social Security Wage Base Remains at $118,500 for 2016 Nanny tax threshold increases to $2,000 for 2016

11 Personal Exemption for 2016 $4,050 Annual Exclusion for Gifts: For calendar year 2016, the first $14,000 of gifts to any person (other than gifts of future interests in property) are not included in the total amount of taxable gifts under Section 2503 made during that year For calendar year 2016, the first $148,000 of gifts to a spouse who is not a citizen of the United States (other than gifts of future interests in property) are not included in the total amount of taxable gifts under Sections 2503 and 2523(i)(2) made during that year

12 Taxpayers Did Not File a Tax Return: Reifler, TC Memo TC held that a joint return not signed by one spouse was not a valid tax return and failure-to-file penalty applied Taxpayer argued that tax the return was valid because: It substantially complied with the valid return rules, or The non-signing spouse intended to file a joint return and tacitly consented to the filing of a joint return Taxpayer did not sign under penalties of perjury

13 Introduction For 2015, tax practitioners need to update themselves with respect to the tax rules relating to payroll taxes, Forms 1099 and fringe benefits in order to give timely, correct advice to their business and individual clients. To that end, this program examines a wide range of important payroll tax, Form 1099 and fringe benefit related topics. cpenow.com / [email protected] 1 NPHR/15/01

14 I. Employee versus independent contractor One of the biggest tax challenges for companies is determining whether workers are employees or independent contractors. If a worker is an employee, then the employer is responsible for withholding income tax and the employee s portion of Social Security and Medicare tax from amounts paid to the worker. The employer is also responsible for paying over to the IRS the employer s portion of Social Security and Medicare tax, as well as paying the federal unemployment tax. From a worker s perspective, employee status results in less tax than if he or she were an independent contractor. As an employee, the worker pays one-half of Social Security and Medicare taxes and his or her employer pays the other half. A self-employed individual pays 100% of those taxes (typically 15.3% of the net wages). Thus the result is that an independent contractor pays double the tax he or she would pay if he or she were an employee. A business that hires an independent contractor typically just pays the independent contractor fee. On the other hand, the business is not responsible for any payroll taxes for independent contractors. Many companies believe that they can choose whether to treat any given worker as an employee or independent contractor. However, there are laws that determine whether the worker is an employee or an independent contractor. So the first step is to properly classify the worker. An employee is an individual who performs services for an employer and who is subject to the employer s control regarding what will be done and how it will be done. If the employer retains the right to direct and control the means and details of the work, then the worker is an employee. The IRS calls this the right to direct and control. It is the only definition, outside of court cases, and it can be found in Treasury Regulations Section (d)-(1)(c), paragraphs (1) and (2). In contrast, an independent contractor is an individual who performs services for a business, but the business controls only the result of the work, not the means and methods of accomplishing the result. A. Revenue Ruling (The 20 Factors) IRS Revenue Ruling contains the twenty common law factors that assess whether or not a business has the right to direct and control the actions of the worker. Although this revenue ruling is still valid today, the IRS has grouped the more relevant factors into three main categories of evidence that show whether a worker is an employee or an independent contractor: Behavioral control; Financial control; and Relationship of the parties. Businesses must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. There is no magic or set number of factors that make the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors that are relevant in one situation may not be relevant in another. The key is to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination. cpenow.com / [email protected] 2 NPHR/15/01

15 1. Behavioral control The key issues for behavioral control are instructions and training. Types of instructions include the following: When and where to do the work; What tools or equipment to use; What workers to hire or to assist with the work; Where to purchase supplies and services; What work must be performed by a specified individual; and What order or sequence to follow when performing the work. The more detailed the instructions, the more control the business exercises over the worker. More detailed instructions indicate that the worker is an employee. Less detailed instructions reflects less control, indicating that the worker is more likely an independent contractor. The next factor under behavioral control is the evaluation system. If an evaluation system measures the details of how the work is performed, then these factors could point to an employee. On the other hand, if the evaluation system measures just the end result, then this could point to either an independent contractor or an employee. Training means explaining detailed methods and procedures to be used in performing a task. If the business provides the worker with training on how to do the job, this indicates that the business wants the job done in a particular way. This is strong evidence that the worker is an employee. Periodic or ongoing training about procedures and methods is even stronger evidence of an employer-employee relationship. When looking at behavioral control, the key factor to consider is whether the business retains the right to control the worker and the details of how the services are performed, regardless of whether the business actually exercises that right. Example: Example: A plumber agrees to install plumbing in a new warehouse being built. Upon arriving at the warehouse, the plumber is given the building plans showing where the plumbing is to be installed, and advised that the plumbing must be completed within five days. This is direction of what is to be done, rather than how it is to be done and is consistent with independent contractor status. A plumber works out of the local plumbers union office. The warehouse general contractor tells the plumber what plumbing has to be done, gives specific instructions on installation, the tools to use, the type of pipe to use, and the order and sequence in which the plumbing is to be installed. These are specific instructions on how the work is to be performed and are consistent with employee status. 2. Financial control Financial control refers to whether or not the business has the right to direct and control the financial aspects of the worker s job. There are several different ways a business exercises financial control. First, there s investment. An independent contractor often has a significant investment in the equipment he or she uses in working for someone else. However, in many occupations, such as construction, workers spend hundreds of dollars on the tools and equipment they use and are still considered to be employees. There are no precise dollar limits that must be met in order to have a significant investment. Furthermore, cpenow.com / [email protected] 3 NPHR/15/01

16 a significant investment is not necessary for independent contractor status as some types of work simply do not require large expenditures. Next are expenses. Employers are more likely to reimburse employees for their job expenses, while businesses usually do not reimburse independent contractors for expenses. However, employees may also incur expenses that are not reimbursed. Example: A teacher buys erasers, posters and other minor supplies throughout the year. She is not reimbursed for these expenses, but minor expenses incurred by an employee do not indicate an independent contractor relationship. She is an employee. The opportunity to make a profit or loss is another important factor. If a worker has a significant investment in the tools and equipment used and if the worker has unreimbursed expenses, the worker has a greater opportunity to lose money for example, their expenses will exceed their income from the work. The possibility of incurring a loss indicates that the worker is an independent contractor. The availability of services should be considered. Are the worker s services available to the market? Independent contractors often advertise, maintain a visible business location and are available for the relevant market. Also, an independent contractor is generally free to seek out business opportunities. Finally, the method of payment must be considered. What type of payment does the worker receive? Is he paid by the job or the hour? Hourly, weekly, or similar basis for payment in return for labor generally is evidence of an employer-employee relationship. A flat fee is generally evidence of an independent contractor, especially if the worker incurs the expenses of performing the services. Furthermore, if a worker continues to be paid during down time, this is evidence the worker is an employee. As with the behavioral control factors, there is no one factor that takes precedence over the others. It s a matter of looking at the whole relationship and seeing where the preponderance of evidence lies. 3. Relationship of the parties Certain elements present in the type of relationship between the two parties may indicate the character of the worker. a. Written contract -- Although a contract may state that the worker is an employee or an independent contractor, this is not sufficient to determine the worker s status. The IRS is not required to follow a contract that simply states that the worker is an independent contractor, responsible for paying his or her own self-employment tax. How the parties work together determines whether the worker is an employee or an independent contractor. b. Employee benefits -- Employee benefits include things like insurance, pension plans, paid vacation, sick days, and disability insurance. Businesses generally do not grant these benefits to independent contractors. However, the lack of these types of benefits does not necessarily mean the worker is an independent contractor. c. Permanent or temporary relationship -- If a business hires a worker with the expectation that the relationship will continue indefinitely, rather than for a specific project or period, this is generally considered evidence that the intent was to create an employeremployee relationship. As mentioned earlier, if the worker continues to be paid during down periods, this points toward a more permanent employer-employee relationship. cpenow.com / [email protected] 4 NPHR/15/01

17 d. Services provided a key activity of the business -- If a worker provides services that are a key aspect of a regular business activity, it is more likely that the business will have the right to direct and control his or her activities. For example, a baker is a key element in the bakery business. It is likely that the bakery would have the right to control or direct that work of the baker because his or her success determines the success of the bakery. This would indicate an employer-employee relationship. e. Casual labor -- With regard to casual labor or day labor, for each worker the business will need to look at all of the factors discussed, and see whether they indicate an employee or an independent contractor. The length of time the worker performs services is not a stand-alone factor in determining his or her status. A worker can be an employee even if he or she only performs a few hours of services. 4. Form SS-8 After reviewing these three categories of evidence, if a business is still unsure whether a worker is an employee or an independent contractor, the business can file Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, with the IRS. The form may be filed by either the business or the worker. The IRS will review the facts and circumstances and officially determine the worker s status. The IRS does not charge a user fee for an SS-8 determination, but a sixmonth wait for an IRS response is not unusual. Key discussion points on the SS-8 relate to behavioral and financial control and relationship of the parties: Behavioral control - Did the taxpayer have a say in how, when, and where to do the work? Financial Control - Did the taxpayer have an investment in the work (other than receiving a salary)? Relationship - Did the taxpayer have benefits like insurance, pensions, or paid leave? Another question on the SS-8 is - Did the taxpayer do this type of work for anyone else? Taxpayers need to have supporting documents, like a 1099, and have the employer s name, address, telephone number, and employer identification number if possible, for the SS-8. B. Form 8919 There may be circumstances where a determination has been made that a worker is an employee, however, the employer continues to treat the worker as an independent contractor and issue him or her Form 1099 in lieu of a W-2. Form 8919, entitled Uncollected Social Security and Medicare Tax on Wages is now available for this situation. Workers who believe they have been improperly classified as independent contractors can use this form to tell the IRS they believe they should be employees, and report only their share of Social Security and Medicare taxes in lieu of self-employment tax. On line 58 of the Form 1040, the taxpayer would list as unreported Social Security and Medicare tax from Form 8919 the amount from the 1099-MISC or the total paid in cash. The earnings are considered wages and would show up on the wages line, page 1 of the The money would be taxed at the wage rate (not the self-employment rate) and Social Security/Medicare taxes would be calculated at the same employee rate. On Form 8919, a worker must select one of eight reasons why he or she believes that he or she is an employee and not an independent contractor. For some of the reason codes, a Form SS-8 must already have been filed. For others, the worker is required to file the SS-8 before filing his or her tax return. cpenow.com / [email protected] 5 NPHR/15/01

18 C. Officers With respect to officers, they are specifically included within the definition of employees for purposes of FICA, FUTA, and federal income tax withholding. Officers are employees by statute under 3121(d)(1). The common law standard is not applicable. However, there is a narrow exception. An officer is not considered to be an employee of the corporation if two requirements are met: The officer does not perform any services or performs only minor services; and The officer is not entitled to receive, directly or indirectly, any remuneration. Sometimes corporations attempt to compensate officers for their services using methods other than wages. These can include: Distributions; Loans to shareholders; Payments of personal expenses; Excessive rent payments; Management fees and/or; Fringe benefits. There are several court cases and rulings indicating that the IRS has the authority to reclassify all or part of these payments made to a corporate officer as wages. D. Misclassification of workers The status of a worker as either an independent contractor or an employee must be determined accurately in order to ensure that workers and businesses can anticipate and meet their tax responsibilities. Businesses decide whether to hire employees or independent contractors depending on individual needs, customer expectations, and worker availability. Either worker classification independent contractor or employee can be a valid and appropriate business choice. The majority of classifications of workers are not challenged by the IRS. However, when IRS reclassifications are made, it can result in the assessment of significant employment tax liabilities. Congress recognized this in 1978 and passed 530 of the Revenue Act of Section 530 provides businesses with relief from federal employment tax obligations if certain requirements are met. It terminates the business s, but not the worker s, liability for the following employment taxes: federal income tax withholding, Social Security and Medicare taxes (FICA), and Federal Unemployment Tax (FUTA). It also means the business is not required to pay any interest or penalties resulting from the liability for employment taxes. 1. Section 530 Relief requirements Section 530 of the Revenue Act of 1978 can relieve businesses of employment tax liability resulting from worker misclassification, but the business must meet the following three requirements to receive relief under 530: Reporting consistency; Substantive consistency; and Reasonable basis. The business must meet ALL three tests. Meeting these three tests means that the business will not owe employment taxes for the workers in question. cpenow.com / [email protected] 6 NPHR/15/01

19 The business must demonstrate two types of consistency: a. First, the business must treat all workers in similar positions the same. This is called substantive consistency. The business (and any predecessor business) must not have treated the workers, or any similar workers, as employees. If the business treated similar workers as employees, this relief provision is not available. In other words, treatment of the workers must be consistent with the position that they were not employees. For example, if the business treated a worker as an independent contractor, it must treat all workers in a similar position as independent contractors. Let s say a business employed 20 workers performing the same duties under the same direction and control, and treated 15 as employees and 5 as independent contractors. In this scenario, the substantive consistency test would not be met. b. Second, the business must file all required federal tax returns on a consistent basis. This is called reporting consistency. This means that if a business believes a particular worker or group of workers are properly classified as independent contractors, then the business must demonstrate to the IRS that they have been filing the required forms for example, Form 1099-MISC for those independent contractors. Relief is not available for any year the business did not file the required Forms 1099-MISC. If they filed the required Forms 1099-MISC for some workers, but not for others, relief is only available for the workers for whom the 1099-MISC was filed. 2. Section Reasonable basis In addition to meeting both consistency tests, the business must also have a reasonable basis for not treating the workers as employees. To establish that a business had a reasonable basis for not treating the workers as employees, it can show that: The business reasonably relied on a court case about federal taxes or a ruling issued to the business by the IRS; or The business s employment tax liabilities were audited by the IRS at a time when it treated similar workers as independent contractors and the IRS did not reclassify those workers as employees; or The business treated the workers as independent contractors because it knew that was how a significant segment of its industry treated similar workers; or The business relied on some other reasonable basis. For example, the business relied on the written advice of a business lawyer or accountant who knew the facts about the business. The IRS takes the position that the judicial precedent relied upon must have been in existence at the time the business made the decision to treat the workers as independent contractors. Additionally, if the business is relying on industry practice, the business will need to show that it knew, at the time it began treating its workers as independent contractors, that this was the industry practice for example, a survey of the industry prior to its treatment. If a business did not have a reasonable basis for treating the workers as independent contractors, it does not meet the relief requirements. E. Form SS-8 Either a business or a worker can file Form SS-8 to obtain an official IRS determination of an individual s worker status. Throughout Form SS-8, the business is called the "Firm" and the independent contractor at cpenow.com / [email protected] 7 NPHR/15/01

20 issue is called the "Worker." Upon receiving the SS-8, the IRS will review the facts and circumstances using the three functional categories discussed above, behavioral control, financial control, and relationship of the parties, and officially determine the worker s status. The IRS does not charge a user fee for an SS-8 determination, but the business should expect to wait many months for the IRS s determination. A wait may be worthwhile, however, if the business expects to continue to hire the same types of workers to perform particular services. The IRS will acknowledge the receipt of Form SS-8. Because there are usually two (or more) parties who could be affected by a determination of employment status, the IRS attempts to get information from all parties involved by sending those parties blank Forms SS-8 for completion. Some or all of the information provided on this Form SS-8 may be shared with the other parties. The case will be assigned to a technician who will review the facts, apply the law, and render a decision. The technician may ask for additional information from the requestor, from other involved parties, or from third parties that could help clarify the work relationship before rendering a decision. The IRS will generally issue a formal determination to the firm or payer (if that is a different entity), and will send a copy to the worker. A determination letter applies only to a worker (or a class of workers) requesting it, and the decision is binding on the IRS. In certain cases, a formal determination will not be issued. Instead, an information letter may be issued. Although an information letter is advisory only and is not binding on the IRS, it may be used to assist the worker to fulfill his or her federal tax obligations. A business s responses to certain questions on Form SS-8 may indicate the worker is an employee while other responses may indicate the worker is an independent contractor. In the IRS s analysis of independent contractor status, there is no set number of factors that make the worker an employee or an independent contractor and no one factor stands alone in making this determination. Also, factors which are important in one kind of industry or working relationship may not be relevant in another. Generally speaking, in determining whether the person providing services is an employee or an independent contractor, all information that provides evidence of the degree of control and independence of the alleged independent contractor must be considered. Neither the Form SS-8 determination process nor the review of any records in connection with the determination constitutes an audit of any federal tax return. If the periods under consideration have previously been examined by the IRS, the Form SS-8 determination process will not constitute a reexamination under IRS reopening procedures. Because this is not an examination of any federal tax return, the appeal rights available in connection with an examination do not apply to a Form SS-8 determination. However, if the requester disagrees with a determination or has additional information concerning the work relationship that he or she believes was not previously considered, he or she may request that the determining office reconsider the determination. F. Voluntary Classification Settlement Program The IRS s Voluntary Classification Settlement Program is an optional IRS program that provides an opportunity for businesses not under an employment tax examination with an opportunity to voluntarily reclassify their workers as employees for employment tax purposes for future tax periods and in return such businesses are partially relieved from prior period federal employment taxes. cpenow.com / [email protected] 8 NPHR/15/01

21 To participate in the VCSP, the taxpayer must meet certain eligibility requirements, apply to participate in the VCSP, and enter into a closing agreement with the IRS. The taxpayer applies to participate by filing Form 8952, Application for Voluntary Classification Settlement Program. Specifically, to be eligible for the VCSP, a taxpayer must: Want to voluntarily reclassify certain workers as employees for federal income tax withholding, Federal Insurance Contributions Act (FICA), and Federal Unemployment Tax Act (FUTA) taxes (collectively, federal employment taxes) for future tax periods; Be presently treating the workers as non-employees; Have filed all required Forms 1099 for each of the workers to be reclassified for the 3 preceding calendar years ending before the date Form 8952 is filed. A taxpayer will meet this requirement if it filed all required Forms 1099 for the workers being reclassified for the period of time that the workers worked for the taxpayer. For example, a taxpayer who has only been in business for 2 years meets this requirement if the taxpayer filed all required Forms 1099 for the workers being reclassified for those 2 years; Have consistently treated the workers as non-employees; Have no current dispute with the IRS as to whether the workers are non-employees or employees for federal employment tax purposes; Not be under employment tax examination by the IRS. If the taxpayer is a member of an affiliated group, this requirement is met only if no member of the affiliated group is under employment tax examination by the IRS; Not be under examination by the Department of Labor or any state agency concerning the proper classification of the class or classes of workers; and Not have been examined previously by the IRS or the Department of Labor concerning the proper classification of the class or classes of workers; or, if the taxpayer has been examined previously by the IRS or the Department of Labor concerning the proper classification of the class or classes of workers, the taxpayer must have complied with the results of the prior examination. A business participating in the VCSP must agree to prospectively treat its workers, or a class or classes of workers, as employees for future tax periods. In exchange, the business: Will pay 10% of the employment tax liability that may have been due on compensation paid to the workers for the most recent tax year, determined under the reduced rates of 3509(a); Will not be liable for any interest and penalties on the amount due to the IRS; and Will not be subject to an employment tax audit with respect to the worker classification of the workers being reclassified under the VCSP for prior years. (For detailed information of the VCSP, see Voluntary Classification Settlement Program (VCSP) Frequently Asked Questions on the IRS website (IRS.gov). cpenow.com / [email protected] 9 NPHR/15/01

22 Advantages and disadvantages of entering VCSP Advantages Low fee for admission--employers accepted into the program will pay approximately 1% of the wages paid to the reclassified workers for the past year in full satisfaction of their federal payroll tax liability. Disadvantages Reclassifying ICs as employees often raises a whole host of legal and fringe benefit issues that are not covered or addressed by VCSP. No interest or penalties will be due, and the employers will not be audited for employment tax classification purposes for prior years with respect to the workers--great opportunity for some businesses to get in good standing with the IRS at minimal cost. State and local employment-related tax and nontax issues are not covered by a VCSP settlement. Businesses may be able to obtain the same or greater employment tax savings through other means. The IRS already maintains a classification settlement program pursuant to 530 whereby a worker will not be reclassified as an employee retroactively assuming that the service recipient meets certain requirements. Employers that participate in the VCSP could be subject to claims for unpaid unemployment taxes and other governmental payments for individuals reclassified as employees. Federal courts sometimes employ a more favorable classification analysis for workers employed in certain industries than does the IRS. Workers classified as ICs could bring lawsuits against the business for benefits that should have been paid to them as employees, but which were not because they were classified as ICs pension contribution, fringe benefits, health benefits, etc. See: Vizcaino v. Microsoft Corporation, 97F.3d 1187 (CA-9,1996) Other federal and state agencies could assert that VCSP participation is an employer admission that it misclassified employees as ICs. cpenow.com / [email protected] 10 NPHR/15/01

23 Planning note: Many of the most critical indicators of employee status are easily avoidable: (i) Giving a worker the business s individual business cards; (ii) Giving the worker an office with his or her name on the door; (iii) Inviting the worker to employer social events such as a summer outing; (iv) Giving the worker a business telephone number and an employer linked address. Sometimes employers believe that if they force a worker to sign a contract that indicates they are independent contractors, that ends the discussion of that worker s federal employment status. The existence of a written agreement purporting to establish independent contractor status is not necessarily determinative of a worker s employment status. The IRS, state labor departments, and courts will look behind any such agreement in order to determine the parties actual employment relationship and will determine an individual s employment status based upon their analysis of the facts and application of the appropriate law. Business owners can run into problems by retaliating against an employee who complained to federal and state agencies that he or she was misclassified as an independent contractor and objects to not being paid overtime. If an employer discriminates or retaliates against an employee because the employee has raised questions with the employer about his or her employment status, that employee may have a right to file a discrimination/retaliation complaint. G. Retirement plan failures resulting from a worker reclassification Retirement plan failures can occur whenever a worker reclassification occurs. IRS continues to update its procedures to correct retirement plan failures using the Voluntary Correction Program (VCP) under the Employee Plans Compliance Resolution system (EPCRS). Revenue Procedure was modified by Revenue Procedures and and include new leniencies. The IRS has released Form as part of this program. H. Department of Labor s Administrator s Interpretation No In Administrator s Interpretation No , the Department of Labor (DOL) issued additional guidance regarding the application of the standards for determining who is an employee under the Fair Labor Standards Act (FLSA). This applies to a worker s entitlement to legal protections such as overtime pay and minimum wage under the FLSA. The analysis of worker status in Administrator s Interpretation No also applies in determining whether a worker is an employee or an independent contractor in cases arising under the Migrant and Seasonal Agricultural Worker Protection Act (MSPA) and the Family and Medical Leave Act (FMLA). In Interpretation No , the DOL uses the economic realities test to determine worker classification. The focus under the economic realities test is to determine whether a worker is economically dependent on the employer, thereby making the worker an employee, versus whether the worker is an independent contractor. The DOL believes that determining the economic independence of a worker should occur on a case-by-case basis, using a multi-factor test using the factors below: (i) Is the work an integral part of the employer s business? (ii) Does the worker s managerial skill affect the worker s opportunity for profit or loss? (iii) How does the worker s relative investment compare to the employer s investment? (iv) Does the work performed require special skill and initiative? (v) Is the relationship between the worker and the employer permanent or indefinite? cpenow.com / [email protected] 11 NPHR/15/01

24 (vi) What is the nature and degree of the employer s control? No one of the above factors is determinative since each factor should be considered in light of the ultimate determination of whether the worker is really in business for himself or herself or is economically dependent on the employer. The economic realities of the relationship and not the label an employer gives it are determinative. Thus, an agreement between an employer and a worker designating or labeling the worker as an independent contractor is not relevant to the analysis of the worker s status. II. New overtime proposals from the Department of Labor President Obama instructed the Department of Labor (DOL) to draw up regulations that would increase the minimum wage and the base amount for workers covered by the Fair Labor Standards Act (FLSA). It is estimated that this change would impact an additional 5 million workers. These changes were not yet finalized when these materials were written. It is estimated the changes will take effect starting in A. Introduction to the Fair Labor Standards Act The FLSA establishes minimum wage, overtime pay, recordkeeping, and child labor standards affecting full-time and part-time workers in the private sector and in federal, state, and local governments. Covered nonexempt workers are entitled to a minimum wage of not less than $5.15 an hour. Overtime pay at a rate of not less than one and one-half times their regular rate of pay is required after 40 hours of work in a workweek. States can still enact their own higher standards if they choose to do so. Workers earning $23,660 or below automatically must receive overtime for hours worked in excess of forty hours per week. The FLSA provides an exemption from both minimum wage and overtime pay for employees employed as bona fide executive, administrative, professional, outside sales employees and certain computer employees. To qualify for exemption, employees generally must meet certain tests regarding their job duties and be paid on a salary basis at not less than $455 per week. Job titles alone do not determine exempt status, however. In order for an exemption to apply, an employee s specific job duties and salary must meet certain requirements. 1. Executive employee exemption To qualify for the executive employee exemption to the FLSA, all of the following tests must be met: The employee must be compensated on a salary basis at a rate not less than $455 per week; The employee s primary duty must be managing the enterprise, or managing a customarily recognized department or subdivision of the enterprise; The employee must customarily and regularly direct the work of at least two or more other full-time employees or their equivalent; and The employee must have the authority to hire or fire other employees, or the employee s suggestions and recommendations as to the hiring, firing, advancement, promotion or any other change of status of other employees must be given particular weight. 2. Administrative employee exemption To qualify for the administrative employee exemption, all of the following tests must be met: The employee must be compensated on a salary or fee basis at a rate not less than $455 per week; cpenow.com / [email protected] 12 NPHR/15/01

25 The employee s primary duty must be the performance of office or non-manual work directly related to the management or general business operations of the employer or the employer s customers; and The employee s primary duty includes the exercise of discretion and independent judgment with respect to matters of significance. 3. Learned professional exemption To qualify for the learned professional employee exemption, all of the following tests must be met: The employee must be compensated on a salary or fee basis at a rate not less than $455 per week; The employee s primary duty must be the performance of work requiring advanced knowledge, defined as work which is predominantly intellectual in character and which includes work requiring the consistent exercise of discretion and judgment; The advanced knowledge must be in a field of science or learning; and The advanced knowledge must be customarily acquired by a prolonged course of specialized intellectual instruction. 4. Creative professional employee exemption To qualify for the creative professional employee exemption, all of the following tests must be met: The employee must be compensated on a salary or fee basis at a rate not less than $455 per week; and The employee s primary duty must be the performance of work requiring invention, imagination, originality or talent in a recognized field of artistic or creative endeavor. 5. Computer employee exemption To qualify for the computer employee exemption, the following tests must be met: The employee must be compensated either on a salary or fee basis at a rate not less than $455 per week or, if compensated on an hourly basis, at a rate not less than $27.63 an hour; The employee must be employed as a computer systems analyst, computer programmer, software engineer or other similarly skilled worker in the computer field performing the duties described below. The employee s primary duty must consist of: o The application of systems analysis techniques and procedures, including consulting with users, to determine hardware, software or system functional specifications; o The design, development, documentation, analysis, creation, testing or modification of computer systems or programs, including prototypes, based on and related to user or system design specifications; o The design, documentation, testing, creation or modification of computer programs related to machine operating systems; or o A combination of the aforementioned duties, the performance of which requires the same level of skills. cpenow.com / [email protected] 13 NPHR/15/01

26 6. Outside sales exemption To qualify for the outside sales employee exemption, all of the following tests must be met: The employee s primary duty must be making sales, or obtaining orders or contracts for services or for the use of facilities for which a consideration will be paid by the client or customer; and The employee must be customarily and regularly engaged away from the employer s place or places of business. 7. Highly compensated employees exemption Highly compensated employees performing office or non-manual work and paid total annual compensation of $100,000 or more (which must include at least $455 per week paid on a salary or fee basis) are exempt from the overtime requirements if they customarily and regularly perform at least one of the duties of an exempt executive, administrative or professional employee identified in the standard tests for exemption. 8. Treatment of blue collar workers There is no exemption for manual laborers or other blue collar workers who perform work involving repetitive operations with their hands, physical skill and energy. FLSA-covered, non-management employees in production, maintenance, construction and similar occupations such as carpenters, electricians, mechanics, plumbers, iron workers, craftsmen, operating engineers, longshoremen, construction workers and laborers are entitled to minimum wage and overtime premium pay under the FLSA, and are not exempt no matter how highly paid they might be. 9. Police and other first responders The exemptions also do not apply to police officers, detectives, deputy sheriffs, state troopers, highway patrol officers, investigators, inspectors, correctional officers, parole or probation officers, park rangers, fire fighters, paramedics, emergency medical technicians, ambulance personnel, rescue workers, hazardous materials workers and similar employees, regardless of rank or pay level, who perform work such as preventing, controlling or extinguishing fires of any type; rescuing fire, crime or accident victims; preventing or detecting crimes; conducting investigations or inspections for violations of law; performing surveillance; pursuing, restraining and apprehending suspects; detaining or supervising suspected and convicted criminals, including those on probation or parole; interviewing witnesses; interrogating and fingerprinting suspects; preparing investigative reports; or other similar work. cpenow.com / [email protected] 14 NPHR/15/01

27 B. FLSA Administrative standards The FLSA does not require breaks or meal periods be given to workers. Some states may have requirements for breaks or meal periods but if the state does not require breaks or meal periods, these benefits are a matter of agreement between the employer and the employee. The FLSA does not limit the number of hours per day or per week that employees aged 16 years and older can be required to work nor does it require payment for time not worked, such as vacations, sick leave or holidays (federal or otherwise). These benefits are a matter of agreement between an employer and an employee (or the employee's representative). Under the FLSA the minimum age for employment in non-agricultural employment is 14. Hours worked by 14- and 15-year-olds are limited to: 3 hours in a school day; 18 hours in a school week; 8 hours on a non-school day; 40 hours on a non-school week; and Hours between 7 a.m. and 7 p.m. (except from June 1 through Labor Day, when evening hours are extended to 9 p.m.) The FLSA sets 14 as the minimum age for most non-agricultural work. However, at any age, youth may deliver newspapers; perform in radio, television, movie, or theatrical productions; work in businesses owned by their parents (except in mining, manufacturing, or hazardous jobs); and perform babysitting or perform minor chores around a private home. The FLSA does not define full-time employment or part-time employment. This is a matter generally to be determined by the employer. Whether an employee is considered full-time or part-time does not change the application of the FLSA. Extra pay for working weekends or nights is a matter of agreement between the employer and the employee (or the employee's representative). The FLSA does not require extra pay for weekend or night work however it does require that covered, nonexempt workers be paid not less than time and one-half the employee's regular rate for time worked over 40 hours in a workweek. Pay raises are generally a matter of agreement between an employer and employee (or the employee's representative). Pay raises to amounts above the federal minimum wage are not required by the FLSA. The FLSA has no provisions regarding the scheduling of employees, with the exception of certain child labor provisions. Therefore, an employer may change an employee's work hours without giving prior notice or obtaining the employee's consent (unless otherwise subject to a prior agreement between the employer and employee or the employee's representative). 1. Stormy weather Business disruption due to bad weather raises interesting employment related questions. If an employer fails to pay a salaried exempt employee for the day(s) when the business was closed because of inclement weather, it would violate the salary basis for the exemption and jeopardize the exempt status of the employee. Similarly, an employer cannot require the exempt employee to use his or her vacation days for the time period when the business was closed, without risking losing the exemption. cpenow.com / [email protected] 15 NPHR/15/01

28 The employer is not obligated to pay an hourly non-exempt employee for the day(s) when the business was closed. Whether the company requires the hourly non-exempt employee to use his or her vacation days is a matter of company policy. If an hourly non-exempt employee is not able to leave the company's facility and go home, because of inclement weather, and continues to work, the company must pay the employee overtime for any hours worked in excess of 40. Whether that employee also is entitled to premium pay for working during this time period is a matter of company policy. With respect to those who report for work but are sent home, most states have no law requiring employers to pay employees a minimum amount of pay for reporting to work in circumstances where the employee is then sent home due to inclement weather. It would be a matter of company policy. Some companies have policies that pay employees a fixed number of hours, for example two hours pay, for reporting to work even though the employee is sent home without having worked the two hours. Such a policy encourages employees to come to work when weather conditions may be uncertain but no decision has been made to close the business. Some states require pay in these circumstances and state law should be reviewed. C. Proposed changes The DOL proposes to update the regulations governing which executive, administrative, and professional employees (white collar workers) are entitled to the FLSA s minimum wage and overtime pay protections. The DOL last updated these regulations in 2004, and the current salary threshold for exemption is $455 per week ($23,660 per year). With this proposed rule, the DOL seeks to update the salary level required for exemption to ensure that the FLSA s intended overtime protections are fully implemented, and to simplify the identification of nonexempt employees, thus making the executive, administrative and professional employee exemption easier for employers and workers to understand and apply. Specifically, the DOL proposes to make the following changes, which probably would take effect starting in 2016: 1. Set the standard salary level at the 40th percentile of weekly earnings for full-time salaried workers ($921 per week, or $47,892 annually); 2. Increase the total annual compensation requirement needed to exempt highly compensated employees (HCEs) to the annualized value of the 90th percentile of weekly earnings of full-time salaried workers ($122,148 annually); and 3. Establish a mechanism for automatically updating the salary and compensation levels going forward to ensure that they will continue to provide a useful and effective test for exemption. The DOL would raise the salary threshold from $455 a week (the equivalent of $23,660 a year) to about $970 a week ($50,440 a year) in The DOL is also proposing to automatically update the standard salary and HCE total annual compensation requirements to ensure that they remain meaningful tests for distinguishing between bona fide executive, administrative, and professional workers who are not entitled to overtime and overtime-protected white collar workers. cpenow.com / [email protected] 16 NPHR/15/01

29 D. Home Care Association of America v. Weil 1 In 1974, Congress exempted third-party providers of home care services from having to pay either minimum or overtime wages to their employees who provide domestic companionship services to seniors and individuals with disabilities, or to pay overtime wages to live-in domestic service employees. (See Fair Labor Standards Amendments of 1974, Pub. L. No , 7(b)(3)-(4), 88 Stat. 55, 62). In 2013, the Department of Labor issued new regulations that takes these longstanding exemptions away from thirdparty employers. A 1974 statute provided that its overtime and minimum wage requirements do not apply to "any employee employed in domestic service employment to provide companionship services for individuals who (because of age or infirmity) are unable to care for themselves (as such terms are defined and delimited by regulations of the Secretary)." (See 29 U.S.C. 213(a)(15) for the "companionship services exemption.") Nor shall its overtime requirements apply to "any employee who is employed in domestic service in a household and who resides in such household." (See 29 U.S.C. 213(b)(21) for the "live-in domestic employee exemption.") The term `domestic service employment' refers to services of a household nature performed by an employee in or about a private home (permanent or temporary) of the person by whom he or she is employed. Examples include cooks, housekeepers, caretakers, chauffeurs, and "babysitters employed on other than a casual basis." Companionship services means "those services which provide fellowship, care, and protection for a person who, because of advanced age or physical or mental infirmity, cannot care for his or her own needs." Services "which require and are performed by trained personnel," such as by nurses, do not qualify as companionship services. "Live-in" workers are domestic service employees who reside in the household where they are employed. The exemptions covered companions and live-in domestic service workers who are employed by an employer or agency other than the family or household using their services. In 2011, the DOL proposed to eliminate these exceptions for third-party employers by regulation and limited the companionship and live-in employee exemptions to workers employed by the family or household using the services, thereby excluding third-party employers from the exemptions. In Home Care Association of America v. Weil, 2 the District Court invalidated these regulations. In 2015, the U.S. Court of Appeals for the District of Columbia reversed the District Court and upheld the DOL regulations. 1 (U.S. Court of Appeals for the District of Columbia Circuit, No ) 2 (Case No. 14-cv-967 United States District Court, District of Columbia, December 22, 2014). cpenow.com / [email protected] 17 NPHR/15/01

30 III. Affordable Care Act implications of worker status classification The distinction between a worker classified as an independent contractor or as an employee is important because businesses must determine how many employees they have for purposes of determining if they are a large employer under the Affordable Care Act (ACA). The ACA s employer penalty regime applies to large employers starting in 2015 that do not provide affordable, legally adequate health insurance to their employees. Determination of large employer status for 2015 is based on the employer s employee census data for Determination of large employer status for 2016 is based on the employer s employee census data for A large employer is a business (or group of related businesses as determined under 414) with 100 or more full-time or full-time equivalent employees for 2015 and 50 or more full-time or full-time equivalent employees for 2016 and after. Workers classified as employees are counted for purposes of this test; those workers classified as independent contractors would not be. Hence it is more important than ever for a business to correctly determine the number of employees it has in order to determine not only its status as a small or large employer but also to determine if a particular worker must be offered employerprovided health insurance coverage. On July 31, 2015, President Obama signed into law H.R. 3236, the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 (the Act) which contained several important tax provisions. Under the Act, effective for months beginning after Dec. 31, 2013, for purposes of determining whether an employer is an ALE for a particular month, an individual is not taken into account as an employee if he or she has medical coverage for that month under the government s TRICARE program, or under the Veterans Administration (VA). Thus, employees covered by TRICARE or VA health care are not counted when determining if an employer exceeds the 50 full-time-employee ALE threshold. As noted, under the ACA the "play or pay" penalties imposed under 4980H can be imposed on a large employer if it does not offer coverage to its full-time employees. Hence it is vital for employers to identify who their employees are and how many are full-time. Section 4980H does not define the term employee, but Proposed Regulations Section H-1(a)(13) provides that the term employee means a common-law employee. These regulations also exclude leased employees, a sole proprietor, a partner in a partnership, or a 2-percent S corporation shareholder from employee status for purposes of the pay or play penalties. A leased employee who is actually a common-law employee of the leasing company and not a common-law employee of the client does not count toward determining whether the client is a large employer and would not be considered a full-time employee of the client for purposes of the pay or play penalty. A. Application of controlled group and affiliated group rules For ACA purposes, all employees of a controlled group or affiliated service group are taken into account in determining whether the group together constitutes an applicable large employer. Generally, this means that if a parent corporation owns 80% or more of the equity in a subsidiary, or if the same 5 or fewer persons own 80% or more of the equity in another company and collectively own more than 50% of both companies, the companies will be considered controlled groups and all employees of the controlled group must be combined together for purposes of calculating whether an employer is a large employer for ACA purposes. cpenow.com / [email protected] 18 NPHR/15/01

31 IV. Tax schedules and Form 1099 The IRS has used the following questions in its Schedules C, E and F to Forms 1120, 1120S and 1065 for several years: Did you make any payments that would require you to file Form(s) 1099? If Yes, did you or will you file all required Forms 1099? It appears unclear what the consequences would be if a taxpayer were to answer yes to the first question but no to the second. Since tax returns are signed under penalties of perjury, it would seem that taxpayers should accurately answer both questions. If a taxpayer were to fail to answer either question, or answer yes to the first and no to the second, a possible consequence could be an IRS correspondence audit and possible assessment of penalties. How the IRS will react to such answers to these questions is unknown at this time. A. Who must file Form 1099-MISC? The directions to the Form 1099-MISC indicate that Form 1099-MISC must be filed for each person to whom you have paid during the year: At least $10 in royalties or broker payments in lieu of dividends or tax-exempt interest; At least $600 in rents, services (including parts and materials), prizes and awards, other income payments, medical and health care payments, crop insurance proceeds, cash payments for fish (or other aquatic life) you purchase from anyone engaged in the trade or business of catching fish, or, generally, the cash paid from a notional principal contract to an individual, partnership, or estate; Any fishing boat proceeds; and Gross proceeds of $600 or more paid to an attorney. In addition, use Form 1099-MISC to report that you made direct sales of at least $5,000 of consumer products to a buyer for resale anywhere other than a permanent retail establishment. You must also file Form 1099-MISC for each person from whom you have withheld any federal income tax under the backup withholding rules regardless of the amount of the payment. B. Trade or business reporting only The Form 1099-MISC instructions also provide: Report on Form 1099-MISC only when payments are made in the course of your trade or business. Personal payments are not reportable. You are engaged in a trade or business if you operate for gain or profit. However, nonprofit organizations are considered to be engaged in a trade or business and are subject to these reporting requirements. C. Exceptions from Form 1099 filing Payments for which a Form 1099-MISC is not required include all of the following: Generally, payments to a corporation; there is an exception for law firms and medical corporations. Payments for merchandise, telegrams, telephone, freight, storage, and similar items. Payments of rent to real estate agents--but the real estate agent must use Form MISC to report the rent paid over to the property owner. cpenow.com / [email protected] 19 NPHR/15/01

32 Wages paid to employees (report on Form W-2, Wage and Tax Statement). Military differential wage payments made to employees while they are on active duty in the Armed Forces or other uniformed services (report on Form W-2). Business travel allowances paid to employees (may be reportable on Form W-2). Cost of current life insurance protection (report on Form W-2 or Form 1099-R). Distributions from pensions. D. Form 1099-MISC filing requirements for landlords Landlords engaged in the trade or business of renting property are required to issue Form 1099s to vendors whom they paid $600 or more. A person engaging in a trade or business is defined as a person who is involved in the activity continuously and regularly and whose main motive in engaging in the activity is for income or profit. A landlord who delegates management duties to an outside management company would not have a Form 1099 filing requirement because he or she is not regularly and continuously involved in the real estate activity and therefore he would not be engaged in a business. Example: A landlord who paid $600 or more to an attorney to collect unpaid rent on his behalf or to a handyman for various repairs in a rental unit over the course of 2015 must answer yes to both questions referred to above on the 2015 Schedule E since the landlord made the payment in the course of a trade or business and the payment amount is above the $600 threshold. (Note: taxpayers are penalized $250 for each Form 1099 intentionally not filed starting in 2016, as discussed below.) E. New penalty regime for 2016 and after New information reporting penalties are effective with respect to tax returns and statements required to be filed with the IRS after December 31, 2015, as set forth on the following chart: Penalty Erroneous or non-filed W-2/1099/1098 (without intentional disregard of filing requirements) Lowered Penalty for Corrections by March 2 Lowered Penalty for Corrections by August 1 Intentional Disregard of Filing Requirements Lower Aggregate Caps for Small Payer-Filers (with no intentional disregard) (applicable to employers/payers with average gross receipts of under $5M during the 3 years before the reporting year) Amount $250 per form, $3M per filer $50 per form, $500K per filer $100 per form, $1.5M per filer $500 per form (or 10% of amount, if greater) with no aggregate cap $1M per filer, lowered to $175K if corrected by March 1, or $500K if corrected by August 1 These penalties apply to both the copy of the form filed with the IRS and the copy filed with an employee (or, for Forms 1099 or 1098, the payee). In practice, the IRS generally does not apply both the penalties under 6721 (IRS copy of the form) and 6722 (employee/payee copy of the form), but technically both penalties could apply. cpenow.com / [email protected] 20 NPHR/15/01

33 These new penalties apply to the information returns filed for 2015 payments and possibly to corrections of pre-2015 information returns, where an error is discovered after 2015, and the correction of that error is filed after These new penalties apply not only to the information reporting boxes that report total income (grossproceeds), but also to other information boxes and to a wide variety of information returns, including mortgage interest statements, payments subject to Fair and Accurate Credit Transactions Act reporting, and information returns required under the Affordable Care Act. The penalty abatement procedures remain the same under the rules outlined in 6724(a), if it can be shown that the failure was due to reasonable cause and not to willful neglect. F. Form 1099 reporting Any trade or business (including a rental business) that makes payments in the course of that trade or business for interest, rent, services, payments to attorneys, etc. aggregating $600 or more for the year to a single payee is required to report the payments to the IRS and to the recipient of the payments by filing IRS Form 1099 and the related IRS Form This rule applies to payments made to individuals, partnerships and LLCs but does not apply to payments to corporations. However, the 1099 reporting requirements do apply to payments made to corporations for attorneys fees and to amounts paid to corporations providing medical or health care services. Thus taxpayers who own rental property of any type that constitutes a trade or business must send a Form 1099 to all non-corporate providers of services, such as landscapers, repair companies, maintenance providers, property managers, etc. Payments made with credit and debit cards are not required to be reported on Forms 1099 as they are reported by the credit card company. Example: Assume Nancy owns a condominium which she rents out. The property management company which Nancy has contracted with to manage the property collected $25,000 total in rent for the year. The property management company retained $2,500 as its fee and distributed the remainder to Nancy. Is Nancy required to issue a Form 1099-MISC to the property management company showing income to the company of $2,500, since this amount is over $600? It appears that whether Nancy must send a Form 1099-MISC to the property management company is not absolutely clear since it is unclear whether Nancy is engaged in a trade or business. It would seem that unless Nancy is in the business of renting properties she would not be required to give a 1099-MISC to the property management company. If the property management company is a corporation, Nancy would be exempt from having to issue a Form 1099-MISC to it. It would appear that the property management company must send Nancy a Form 1099-MISC since that is a payment it made to Nancy in the course of the property management company s trade or business. For a discussion regarding when property ownership is a trade or business, see cpenow.com / [email protected] 21 NPHR/15/01

34 V. Affordable Care Act information reporting Form 1095-C (and the related transmittal Form 1094-C will be filed by applicable large employers (ALEs) to report on coverage offered to employees. The IRS will use information from this form to enforce the employer shared responsibility penalty and identify individuals that are ineligible for premium assistance credits. These reporting forms are summarized as follows: Form 1095-B, Health Coverage (See IRS Publication 5215) Insurers and self-funded plans will provide one to each enrollee. Form 1095-B provides information on the health coverage provided B, Transmittal of Health Coverage Information Returns Form 1094-B is a transmittal form insurers and self-funded plans will file with IRS along with all the Forms 1095-B. Form 1095-C, Employer-Provided Health Insurance Offer and Coverage (See IRS Publication 5196) Applicable Large Employers will provide Form 1095-C to each enrollee. Form 1095-C provides information on the coverage provided, and on to whom and when the coverage was offered. Form 1094-C, Transmittal of Employer- Provided Health Insurance Offer and Coverage Information Returns Form 1095-A, Health Insurance Marketplace Statement Form 8962, Premium Tax Credit Form 8965, Health Coverage Exemptions Form 1094-C is a transmittal form insurers and self-funded plans will file with the IRS along with all the Forms 1095-C. Exchanges will provide Forms 1095-A to their enrollees. Individuals who receive a premium tax credit will file Form 8962 along with their Form Individuals claiming an exemption from the individual mandate will file Form 8965 along with their form Large Employer Information Reporting is effective for calendar years after December 31, 2014; a date reflecting the one-year delay for the large employer shared responsibility penalty. The 2015 reports to the IRS are to be filed no later than February 28, 2016 (but because this is a Sunday, it is actually March 1, 2016), and no later than March 31 if reporting electronically. Electronic filing is required for all large employers filing at least 250 returns (each full-time employee is counted as a separate return). Those filing fewer than 250 returns may choose to file in paper form, but are permitted (and encouraged) to file electronically. The 2015 reports to full-time employees are due by January 31, 2016 (but because this is a Sunday, it is actually February 1, 2016). cpenow.com / [email protected] 22 NPHR/15/01

35 VI. Entity selection and fringe benefits A fringe benefit is a payment of some kind for the performance of services. A person who performs services for a business does not have to be the business s employee as a person may perform services for the business as an independent contractor, partner, or director. Also, for fringe benefit purposes, a taxpayer should treat a person who agrees not to perform services (such as under a covenant not to compete) as performing services. A business is the provider of a fringe benefit if the benefit is provided for services performed for the business. A business is considered to provide a fringe benefit even if a third party, such as a client or customer, provides the benefit. Any fringe benefit a business provides is taxable and must be included in the recipient's pay unless the law specifically excludes the benefit from income taxation. If the recipient of a taxpayer fringe benefit is an employee, the benefit is subject to employment taxes and must be reported on Form W-2. The business can use special rules to withhold, deposit, and report the employment taxes. If the recipient of a taxable fringe benefit is not an employee, the benefit is not subject to employment taxes; however the business may have to report the benefit on one of the following information returns: Status of recipient Independent contractor Form 1099-MISC, Miscellaneous Income Employee Schedule K-1 (Form 1065), Partner's Share of Income, Deductions, Credits, etc. A. Retirement plans With respect to retirement plans, there is near parity among entities in terms of deductions and benefits although two advantages exist with respect to the pension plan of a C corporation. A plan participant in a C corporation s retirement plan may borrow up to $50,000 from a corporate pension plan provided that the loan is secured, the plan allows for loans, and the loan's terms are similar to those required by a financial institution. In addition, corporate pension plans subject to ERISA receive more court protection from creditors than unincorporated plans. VII. Health insurance and the Affordable Care Act A C corporation s ability to fully deduct a shareholder/employee s health insurance is an advantage a C corporation has had over an S corporation or a partnership and remains in place after the Affordable Care Act. A C corporation can deduct 100% of the health insurance it pays for its employees, including employees who are shareholders in the corporation and it can fully deduct the costs of any medical reimbursement plan. A small or medium size business operated as a C corporation that does not buy insurance can self-insure and deduct all of its employees covered expenses. C corporations also can deduct fringe benefits such as qualified education costs, group term life insurance up to $50,000 per employee and employer-provided vehicles and public transportation passes. A greater than 2% S corporation shareholder and a partner are not entitled to the exclusion of certain cpenow.com / [email protected] 23 NPHR/15/01

36 fringe benefits from income. The value of the health insurance provided to partners and greater than 2% S corporation shareholders is included in the income of the partner/s corporation shareholder and may be deductible to the partnership/s corporation as a business expense and to the partner/s corporation shareholder on Line 29 of the Form An employer should not exclude the following fringe benefits from the income of highly compensated employees unless the benefit is available to other employees on a nondiscriminatory basis: No-additional-cost services; Qualified employee discounts; Meals provided at an employer-operated eating facility; or Reduced tuition for education. An employer may add the value of fringe benefits to regular wages for a payroll period and figure withholding taxes on the total, or it may withhold federal income tax on the value of the fringe benefits at the flat 25% supplemental wage rate. Whether a statutory provision allowing an exclusion of a fringe benefit from income is applicable to partners/greater than 2% S corporation shareholders must be determined with respect to each particular fringe benefit. There are several tax-free benefits, however, that a partnership or S corporation can provide to a partner or S corporation shareholder and deduct without any resulting income to the partner or S corporation shareholder. For example, the partnership or S corporation can pay job-related education expenses for the partner or shareholder and deduct the cost without the partner or shareholder recognizing income. With respect to educational assistance programs (which can be used for job-related or unrelated education), there are limits on the portion of the total benefits paid out that can be paid to owners of 5% of the partnership or S corporation and their dependents. Payments can be made to partners under qualifying dependent care assistance programs, provided that no more than 25% of the amounts paid annually are paid to 5% owners of the partnership or S corporation. Other tax-free benefits include job placement assistance and provision of an automobile (to the extent used for business). (The partner or shareholder s personal use of the automobile is, of course, taxable to the partner or shareholder as compensation income.) If the partnership or S corporation reimburses the partner or shareholder for club dues, the reimbursement is not deductible by the partnership or S corporation, but the portion of the dues allocable to business use can be received by the partner or shareholder tax-free. There are also de minimis benefits provided on an occasional basis, such as traditional birthday or holiday gifts of low value, event tickets, traditional awards (such as a retirement gift), and other special occasion gifts. Another de minimis fringe benefit is transportation assistance consisting of a monthly amount of tokens or fare cards for public transit furnished to the partner by the partnership. These can all be given to the partner and their cost deducted by the partnership, without any resulting taxable income to the partner. Generally, the rules relating to whether the owner of a pass-through entity is entitled to a tax-free fringe benefit occur in the context of a partnership and its partners. However, 1372 provides that for fringe-benefit purposes, more-than-2% S corporation shareholder-employees are subject to the rules that apply to partners, and S corporations are treated as partnerships for this purpose. As a result, the tax consequences of fringe benefits for members of LLCs taxed as partnerships and for more-than-2% S shareholderemployees are the same as they are for partners. cpenow.com / [email protected] 24 NPHR/15/01

37 A. Notice IRS Notice held that employer payment plans are group health plans that will fail to comply with the market reforms that apply to group health plans under the Affordable Care Act (ACA). For this purpose, an employer payment plan as described in Notice refers to a group health plan under which an employer reimburses an employee for some or all of the premium expenses incurred for an individual health insurance policy or directly pays a premium for an individual health insurance policy covering the employee. Notice provides transition relief from the assessment of excise tax under 4980D for failure to satisfy market reforms in certain circumstances and the obligation to report violations on Form The transition relief applies to employer healthcare arrangements that constitute one of the following: 1. Employer payment plans, as described in Notice , if the plan is sponsored by an employer that is not an Applicable Large Employer (ALE) under 4980H(c)(2) and H- 1(a)(4) and -2; 2. S corporation healthcare arrangements for 2-percent shareholder employees; 3. Medicare premium reimbursement arrangements; and 4. TRICARE related health reimbursement arrangements (HRAs). An employer payment plan is any arrangement through which an employer pays, directly or indirectly (e.g. including direct or indirect payments with after-tax dollars), an employee s premiums for major medical coverage purchased in the individual market (inside or outside the exchange) and/or Medicare Part B or D premiums. Employer payment plans will violate one or more of the health insurance reforms added by the ACA including but not limited to the prohibition on annual dollar limits on essential health benefits and the requirement to provide preventative care without cost sharing and as such, excise taxes of up to $100 per day per employee would apply under 4980D. Notice did not change the conclusions reached in Notice regarding employer payment plans and HRAs. Arrangements that pay or reimburse an employee s premiums for major medical coverage purchased in the individual market still violate the health insurance reforms added by the ACA. Rather, Notice provides limited relief from the excise taxes that would otherwise be imposed under 4980D on such arrangements. B. Small employer transition relief Employers that maintained an employer payment plan would not be subject to the 4980D excise taxes because they maintain such a plan, if they were not an ALE, in 2014 and through June 30, An employer is not an ALE for a year if it employed on average less than 50 full-time equivalents in the prior calendar year. C. Subchapter S Arrangements Notice provides that if an S corporation pays for or reimburses premiums for individual health insurance coverage covering a more-than-2-percent shareholder, the payment or reimbursement is included in income but the more-than-2-percent shareholder-employee may deduct the amount of the premiums under 162(l). At least until the end of 2015, transition relief is provided for certain arrangements whereby Subchapter S corporation more-than-2-percent shareholders took a 162(l) deduction for individual market coverage. According to the Notice, transitional relief was granted to allow cpenow.com / [email protected] 25 NPHR/15/01

38 IRS and DOL time to collaborate on a publication since the guidance in Notice is in direct conflict with the guidance in Notice regarding S corporations. Notice provides that certain employer payment plans that reimburse Medicare Part B and/or D premiums will be considered integrated with a group health plan for purposes of the health insurance reforms if the following conditions are satisfied: The employer offers a group health plan (other than the employer payment plan) that provides minimum value coverage; The employee participating in the employer payment plan is actually enrolled in Medicare; The employer payment plan is available only to those who are enrolled in Medicare; and The employer payment plan limits reimbursement to Medicare Part B or D premiums and excepted benefits, including but not limited to Medigap premiums. D. Tricare Arrangements Tricare, like Medicare, is not considered an employer group health plan. As a result, such coverage cannot be integrated with an employer payment plan (such as a plan reimbursing individual medical premiums). Notice provides relief for HRAs that reimburse expenses incurred by employees covered by Tricare. Such an arrangement will be considered integrated with a "group health plan" for purposes of the health insurance reforms if the following conditions are satisfied: The employer offers a group health plan (other than the reimbursement arrangement) that provides minimum value; The employee participating in the reimbursement arrangement is actually enrolled in Tricare; The reimbursement arrangement is available only to those who are enrolled in Tricare; and The reimbursement arrangement limits reimbursement to cost sharing under Tricare and excepted benefits, including Tricare supplemental arrangements. E. After-tax Arrangements An increase in pay without creation of an ERISA plan and that is not restricted to premium reimbursements is acceptable under Notice If an employer increases compensation to assist employees with payments for individual market coverage but does not take action that would otherwise result in the creation of an ERISA plan (e.g., endorsement), the arrangement is not an employer payment plan, as long as the increased compensation is not conditioned on the employee's purchase of individual market coverage. F. Anti-discrimination rules under 105(h) Practitioners should be alert to the eventual release of new regulations under 105(h) that will apply antidiscrimination rules, required by the Affordable Care Act, to fully insured health insurance plan sponsors. It will no longer be possible to discriminate with respect to which employees are covered with health insurance once these rules take effect. Self-insured plans are already subject to these anti-discrimination rules. cpenow.com / [email protected] 26 NPHR/15/01

39 As of the date of issuance of these materials, fully insured plan sponsors are not yet subject to the ACA requirement to conduct 105(h) testing and will not be so until the IRS issues regulations on point; but as noted, self-insured plans are still subject to nondiscrimination testing. Section 105(h) provides that a self-insured medical reimbursement plan must not discriminate in favor of highly compensated individuals (HCIs) as to eligibility to participate; and the benefits provided under the plan must not discriminate in favor of participants who are HCIs. Self-insured plans subject to 105(h) include: medical plans, dental plans, flex spending plans, and health reimbursement arrangements (HRAs). G. Highly compensated individuals for 105(h) purposes Section 105(h)(5) provides that an HCI is an individual who is: One of the 5 highest paid officers; A shareholder who owns more than 10 percent in value of the stock of the employer; or Among the highest paid 25 percent of all employees (other than excluded employees who are not participants). Section 105(h)(3)(B) provides that the following individuals may be excluded from consideration: Employees who have not completed 3 years of service; Employees who have not attained age 25; Part-time or seasonal employees; Employees not included in the plan who are included in a unit of employees covered by an agreement between employee representatives and one or more employers which the IRS finds to be a collective bargaining agreement, if accident and health benefits were the subject of good faith bargaining between such employee representatives and such employer or employers; and Employees who are nonresident aliens and who receive no earned income. H. Anti-discrimination tests Self-insured health insurance plans must pass tests for eligibility and benefits. The eligibility tests consist of the 70% Test, the 80% Test and the Classifications Test. A plan need pass only one of the three tests to establish that it does not discriminate in favor of HCIs. The 70% test requires that the plan provides benefits to 70% or more of all employees. If plans fail this test, then it must be determined if the plan provides benefits to 80% or more of all the employees who are eligible to benefit under the plan. If the plan cannot pass the 70% test or 80% test, then it must be determined if the plan is providing benefits-based classifications set up by the employer and found by the IRS not to be discriminatory in favor of HCIs. If a self-insured health insurance plan passes non-discrimination testing for eligibility, it must then show that it does not discriminate in favor of HCIs with respect to benefits. Reg. Section (c)(3)(i) states that in general benefits subject to reimbursement under a plan must not discriminate in favor of HCIs. Plan benefits will not satisfy the non-discrimination requirement unless all benefits provided to HCIs are provided to all participants. In addition, all the benefits available for the dependents of employees who are HCls must also be available on the same basis for the dependents of all other employees who are participants. cpenow.com / [email protected] 27 NPHR/15/01

40 If a self-insured health insurance plan discriminates in favor of HCIs as to eligibility to participate, then the eligibility criteria would have to be adjusted accordingly. Similarly, if the benefits provided under the plan discriminate in favor of HCIs, then these benefits would have to be made available to the non-hci participants as well. Planning point: Employer health plan contributions can be a source of testing failure, especially if owners and officers are provided with coverage at no cost. The easiest remedy for this sort of failure is to impute the value of the normal employee plan contribution in gross wages. If a business does not correct a discriminatory plan, then amounts paid to HCIs may constitute an excess reimbursement and are taxable to the HCIs. 1. Section 105(h) penalties When the ACA extended to insured group health plans the 105(h) non-discrimination provisions which previously had been applicable only to self-insured group plans the question arose about penalties for violation. The ACA did not create a new set of restrictions for insured plans but merely extended and modified an existing system to them. Penalties for violators of the non-discrimination provisions with respect to self-insured plans, however, appear to be different from those applicable to insured health plans. For employers with self-insured plans, the executive or highly compensated individual who benefited from the plan must include the value of those benefits in his or her gross income. It appears that employers with insured plans will not be subject to this penalty but instead, the employer will be responsible for a $100 per day per covered employee excise tax penalty. I. ERISA and the Fair Labor Standards Act Section 510 of the Employee Retirement Income Security Act (ERISA) provides that employers may not discharge, fine, suspend, expel, discipline or discriminate against a participant or beneficiary... for the purpose of interfering with the attainment of any right to which such participant may become entitled under the plan... Some commentators assert that 510 of ERISA may prevent employers from adopting a common strategy many businesses are exploring so as to minimize the cost of the large employer penalty reducing some or all full-time employees to part-time employees. The ACA does not require an employer to offer full-time employees health coverage; it gives an employer the option of offering its full-time employees minimum essential coverage or paying a penalty. An employer that does not offer health insurance to its employees does not have a plan and presumably chooses to pay the penalty. If an employer plans to limit a segment of its workforce s hours of service to less than 30 hours per week, the strategy would not violate 510 since 510 only protects a participant that is in a plan. When an employer has no plan, 510 does not offer protection to any employee. In Curtis-Wright Corporation v. Schoonejongen, 3 the United States Supreme Court held that an employer is not required to offer health insurance coverage to its employees and that if it did, an employer may modify or terminate a health plan at any time and for any reason. Thus, under Curtis Wright, an employer is free to select which employees it covers, if any, in a health plan it adopts. Additionally, if there is an existing plan, an employer is free to amend the plan as part of a fundamental business decision U.S. 73 (1995). cpenow.com / [email protected] 28 NPHR/15/01

41 If, however, an employer s health insurance plan defines a plan participant by referencing the ACA, a claim that the employer violated 510 is more plausible. An employer, for example, could define a participant in its health insurance plan as a full-time employee as defined by the ACA. The effect would be that the employer would provide health insurance coverage to all of its employees working 30 or more hours a week. Defining a covered employee in this way would leave the employer potentially subject to a claim under 510. If a health insurance plan participant were defined solely based on an employee s hours of service, the reduction of any employee s hours of service could be constructed under 510 as interference with the attainment of any right under a plan. In an attempt to counter potential liability under 510, some commentators have suggested that employers define a participant in a health insurance plan based on an employee s job title and not on hours of service. In this case, the employee s eligibility for coverage will not be predicated on the employee s hours of service. Thus, an employer reducing an employee s hours of service will not in any way be interfering with the attainment of any right under the plan. If such a policy were adopted, it would be important for an employer to insure that employees that do not have a job title covered by the plan do not accumulate the requisite hours of service to be considered fulltime employees under the ACA. An employer that does not follow this critical step could fail the 70% coverage rule in 2015 or the 95% coverage rule in As a result the employer would still pay a portion of the premiums for part of its workforce while still paying a penalty. 1. Fair Labor Standards Act 18C The ACA added 18C, "Protections For Employees," to the Fair Labor Standards Act (FLSA). This provision prohibits employers from discriminating against an employee with respect to his/her compensation, terms, conditions or other privileges of employment because the employee received a premium tax credit. Section 18C of the FLSA provides that the employee would have the burden of proof. The employee would have to demonstrate that the employee receiving a premium tax credit was a contributing factor in the employer s decision to reduce the employee s hours of service. If the employee can make a prima facie case, the employer has to demonstrate by clear and convincing evidence that the employer would have reduced the employee s hours of service regardless of whether the employee received a premium tax credit. The problem for an employee making such a claim is an employer will never know which specific employee is receiving a premium tax credit so even making a prima facie case will be challenging for an employee. cpenow.com / [email protected] 29 NPHR/15/01

42 VIII. Accountable plans To be an accountable plan, an employer's reimbursement or allowance arrangement must meet all of the following rules. 1. The employee s expenses must have a business connection that is, the individual must have paid or incurred deductible expenses while performing services as an employee of the individual s employer. 2. The employee must adequately account to his or her employer for these expenses within a reasonable period of time. 3. The employee must return any excess reimbursement or allowance within a reasonable period of time. An excess reimbursement or allowance is any amount an employee is paid that is more than the business-related expenses that the employee adequately accounted for to his or her employer. The definition of reasonable period of time depends on the facts and circumstances of a taxpayer s situation. However, regardless of the facts and circumstances of the taxpayer s situation, actions that take place within the times specified in the following list will be treated as taking place within a reasonable period of time: Taxpayer receives an advance within 30 days of the time he or she has an expense. Taxpayer adequately accounts for his or her expenses within 60 days after they were paid or incurred. Taxpayer returns any excess reimbursement within 120 days after the expense was paid or incurred. Taxpayer is given a periodic statement (at least quarterly) that asks him or her to either return or adequately account for outstanding advances and the taxpayer complies within 120 days of the statement. A. How employees comply with accountable plan rules Under accountable plan rules, an employer should not include any employee reimbursements in the employee s income in box 1 of his or her Form W-2. If the employee s expenses equal his or her reimbursements, he or she does not complete Form The employee has no deduction since his or her expenses and reimbursements are equal. If an employee s employer included reimbursements in box 1 of the employee s Form W-2 and the employee meets all the rules for accountable plans, the employee should ask his or her employer for a corrected Form W-2. B. Consequences of not complying with accountable plan rules Even though the employee is reimbursed under an accountable plan, some of his or her expenses may not meet all three rules. All reimbursements that fail to meet all three rules for accountable plans are generally treated as having been reimbursed under a nonaccountable plan, which is discussed later in these materials. If an employee is reimbursed under an accountable plan, but he or she fails to return, within a reasonable time, any amounts in excess of the substantiated amounts, the amounts paid in excess of the substantiated expenses are treated as paid under a nonaccountable plan. cpenow.com / [email protected] 30 NPHR/15/01

43 An employee may be reimbursed under the employer's accountable plan for expenses related to that employer's business, some of which are deductible as employee business expenses and some of which are not deductible. The reimbursements the employee receives for the nondeductible expenses do not meet rule (1) for accountable plans, and they are treated as paid under a nonaccountable plan. Example: Mary s employer's plan reimbursed her for travel expenses while she was away from home on business and also for meals when she worked late at the office, even though she was not away from home. The part of the arrangement that reimbursed her for the nondeductible meals when she worked late at the office would be treated as paid under a nonaccountable plan. The employer makes the decision whether to reimburse employees under an accountable plan or a nonaccountable plan. If the employee receives payments under a nonaccountable plan, the employee cannot convert these amounts to payments under an accountable plan by voluntarily accounting to his or her employer for the expenses and voluntarily returning excess reimbursements to the employer. An employee must adequately account to his or her employer for his or her expenses under an accountable plan. An employee adequately accounts by giving the employer a statement of expense, an account book, a diary, or a similar record in which the employee entered each expense at or near the time he or she incurred it, along with documentary evidence (such as receipts) of his or her travel, mileage, and other employee business expenses. A per diem or car allowance satisfies the adequate accounting requirement under certain conditions. An employee must account for all amounts he or she received from his or her employer during the year as advances, reimbursements, or allowances. This includes amounts the employee charged to his or her employer by credit card or other method. The employee must give his or her employer the same type of records and supporting information that the taxpayer would have to give to the IRS if the IRS questioned a deduction on the employee s income tax return. The employee must pay back the amount of any reimbursement or other expense allowance for which he or she does not adequately account or that is more than the amount for which the employee accounted. C. Nonaccountable plans A nonaccountable plan is a reimbursement or expense allowance arrangement that does not meet one or more of the three rules listed earlier under accountable plans. In addition, even if an employer has an accountable plan, the following payments will be treated as being paid under a nonaccountable plan: 1. Excess reimbursements the employee fails to return to his or her employer; and 2. Reimbursement of nondeductible expenses related to his or her employer's business. An arrangement that repays an employee for business expenses by reducing the amount reported as wages, salary, or other pay will be treated as a nonaccountable plan. This is because the employee is entitled to receive the full amount of his or her pay whether or not he or she has any business expenses. D. Reporting employee expenses under a nonaccountable plan An employer will combine the amount of any reimbursement or other expense allowance paid to an employee under a nonaccountable plan with the employee s wages, salary, or other pay. The employer will report the total in box 1 of the employee s Form W-2. The employee must complete Form 2106 or 2106-EZ and itemize his or her deductions to deduct expenses for travel, transportation, meals, or entertainment. The employee s meal and entertainment expenses will be subject to the 50% limit and the cpenow.com / [email protected] 31 NPHR/15/01

44 employee s total expenses will be subject to the 2%-of-adjusted-gross-income limit that applies to most miscellaneous itemized deductions. IX. Form W-2 reporting under the ACA The Affordable Care Act (ACA) requires employers to report the cost of coverage under an employersponsored group health plan. Reporting the cost of health care coverage on the Form W-2 does not mean that the coverage is taxable. The value of the employer s excludable contribution to health coverage continues to be excludable from an employee's income, and it is not taxable. This reporting is for informational purposes only and will provide employees useful and comparable consumer information on the cost of their health care coverage. The IRS indicated that the purpose of the reporting is to provide useful and comparable consumer information to employees on the cost of their health care coverage. The amount that must be reported must include both the portion paid by the employer and the portion paid by the employee. However, the employee s salary reduction contribution to a health FSA would not be included in the reportable amount. The amount reported also includes the value of any coverage that is reported to the employee as imputed income, such as coverage for an adult dependent who attained the age of 27 during the taxable year. The amount is reported on the Form W-2 in a new Box 12, and is identified by code DD. The amount would not be included on the Form W-3, Transmittal of Wage and Tax Statements. Employers that provide "applicable employer-sponsored coverage" under a group health plan are subject to the reporting requirement. This includes businesses, tax-exempt organizations, and federal, state and local government entities (except with respect to plans maintained primarily for members of the military and their families). However, federally recognized Indian tribal governments are not subject to this requirement. For purposes of W-2 reporting, retirees are not treated as employees, do not receive a Form W-2, and accordingly there is no obligation to report the value of health coverage to a retired employee. Those participants who are receiving coverage because of COBRA eligibility would not be required to receive a Form W-2, unless they are otherwise entitled to one and accordingly are not subject to this reporting requirement. Coverage for on-site medical clinics must be reported as must dental and vision plans that are integrated with the employee s medical plan. Form W-2 reporting applies to all employers that provide employer-sponsored health coverage, which means health plan coverage made available by employers to their employees that is excludable from the employees income under the Internal Revenue Code, are subject to this rule, including the following employers: Federal, state and local government entities (except with respect to plans maintained primarily for members of the military and their families); Churches and other religious organizations; and Employers not subject to the continuation of coverage requirements under the Consolidated Omnibus Budget Reconciliation Act (COBRA) - generally employers with fewer than 20 employees. cpenow.com / [email protected] 32 NPHR/15/01

45 A. Transition relief from W-2 reporting Until the IRS gives notice, the following employers are not subject to the Form W-2 reporting requirements: Employers filing fewer than 250 Forms W-2; Employers that contribute to multiemployer plans; Health Reimbursement Arrangements (HRAs); Dental and vision plans that are not integrated into a group health plan; and Self-insured plans of employers not subject to COBRA continuation coverage or similar federal requirements. Practitioner note: The IRS website (IRS.gov) has a chart which lists benefits which need not be reported on the Form W-2 as well as benefits which the employer must report and those for which it has an option to report. (See Sponsored-Health-Coverage). B. Limits on out-of-pocket caps The maximum out-of-pocket costs for any Marketplace plan for 2015 are $6,600 for an individual plan and $13,200 for a family plan. This means when the amount an individual paid in deductibles, copayments, and coinsurance reaches these limits, the insurance company pays 100% of the individual s costs for covered care. Even if the individual chooses a catastrophic coverage plan, his or her out-of-pocket costs should not exceed this limit. C. Notification of Health Insurance Marketplace Employers subject to the Fair Labor Standards Act (FLSA) must comply with Department of Labor mandated notification requirements. Generally, FLSA applies to employers that employ one or more employees who are engaged in or produce goods for interstate commerce and generate at least $500,000 in annual revenue. It also includes hospitals, nursing homes, schools, and government agencies. Thus if a business has more than $500,000 in sales and has at least one employee, it is subject to this requirement. The notice must include information regarding the existence of the marketplace, contact information, and a description of the services provided by the marketplace. The notice must also inform the employee that he or she may be eligible for a premium tax credit. Employees hired after October 1, 2013 must receive notification at the time of hiring (notice is considered given at the time of hiring if it is provided within 14 days of an employee's start date). Notice may be delivered in person, by first-class mail or electronically. The Department of Labor has issued sample forms to use when issuing these notices. The following are links to Model Notices contained on the Department of Labor's website: For employers that offer health insurance: For employers that do not offer health insurance: cpenow.com / [email protected] 33 NPHR/15/01

46 X. Cafeteria plans A cafeteria plan is a written plan that allows employees to choose the form of employee benefits they desire from a cafeteria of plan benefits provided by their employer. Cafeteria plans must include a cash option as one of the available options. If an employee chooses to receive a qualified benefit under the plan, the fact that the employee could have received cash or a taxable benefit instead will not make the qualified benefit taxable. Although cafeteria plans are not required to permit new elections due to a change in status, cafeteria plans may permit a participant to revoke an existing election and make a new election for the remaining period of coverage if a change in status occurs and the election change is consistent with the change in status. The following is a nonexclusive listing of events that are considered changes in status: A change in the employee's marital status; A change in the employee's number of dependents; and A change in the employment status of the employee, spouse, or dependent. Only the employee, and not the employee's spouse or dependent, is permitted to change the cafeteria plan election. Generally, a cafeteria plan does not include any plan that offers a benefit that defers pay. A 125 plan is the only means by which an employer can offer employees a choice between taxable and nontaxable benefits without the choice causing the benefits to become taxable. A plan offering only a choice between taxable benefits is not a 125 plan. The following chart indicates most of the cafeteria options that can and cannot be offered in a cafeteria plan. cpenow.com / [email protected] 34 NPHR/15/01

47 Qualifying benefits Nonqualifying benefits Accident and health benefits. COBRA premium. Medical savings accounts or long-term care insurance. Contributions to health savings accounts. Premiums for certain qualified health plans offered through a health benefits exchange after Adoption assistance. Athletic facilities. Dependent care assistance. De minimis (minimal) benefits. Group-term life insurance coverage. Educational assistance. Long-term disability insurance. Employee discounts. Parking benefits. Lodging on your business premises. 401(k) plan contributions. Meals Moving expense reimbursements. No-additional-cost services. Transportation (commuting) benefits. Tuition reduction. Working condition benefits. Scholarships or fellowships. In terms of providing coverage to employees, cafeteria plans must treat the following individuals as employees: A current common-law employee. A full-time life insurance agent who is a current statutory employee. A leased employee who has provided services on a substantially full-time basis for at least a year if the services are performed under the taxpayer s primary direction or control. cpenow.com / [email protected] 35 NPHR/15/01

48 S corporations may not treat as an employee of an S corporation an individual who directly or indirectly owns (at any time during the year) more than 2% of an S corporation's stock or S corporation stock with more than 2% of the voting power. A. Nondiscrimination requirements A cafeteria plan may not discriminate in favor of highly compensated individuals as to eligibility, contributions, or benefits and may not provide benefits to key employees in excess of 25% of the aggregate of such benefits provided for all employees under the plan. If a plan violates either of these requirements, the highly compensated individuals and key employees must include in income the value of the taxable benefit with the greatest value that they could have elected to receive, even if they elected to receive only nontaxable benefits. A plan maintained under a collective bargaining agreement does not by definition favor highly compensated employees. A highly compensated individual is an officer, shareholder owning 5% or more of the voting power or value of all classes of stock of the employer, or the spouse or dependent of any of the above. Section 125(g)(3) provides a safe harbor eligibility provision: A cafeteria plan is not discriminatory if it benefits a group of employees under a classification that does not discriminate in favor of highly compensated employees and covers all employees with three years of service. The three years of service begins no later than the first day of the plan year after the three years of service is attained. Planning note: A cafeteria plan can allow employees to change their elections during the cafeteria plan year only in limited circumstances, such as when the employee has experienced a "change in status." A change in status includes a change in the employee's legal marital status; a change in the number of dependents; a change in employment status constituting a termination or commencement of employment by the employee, spouse or dependent; a dependent's satisfying or ceasing to satisfy eligibility requirements for coverage because of age, student status, or similar circumstances; and a change in the residence of the employee, spouse, or dependent. Employment-status changes include a strike, a lockout, and a commencement of or return from an unpaid leave of absence, and provide a more flexible rule for other change-in-employment-status events. For example, if a plan applies only to salaried employees and an employee switches from salaried to hourly, that change would be considered a change in employment status. If a taxpayer has only a cafeteria plan, it is not required to file Form 5500 or Schedule F of Form However, if an employer has a welfare benefit plan, it is required under Department of Labor regulations to file a Form 5500 for that plan. Thus an employer that maintains a group health plan with 100 or more participants, together with a cafeteria plan or other fringe benefit plan, must file Form 5500 for the health plan only. The employer need not file Schedule F to the Form 5500, however, for the fringe benefit plan(s). B. Flexible spending accounts A flexible spending account (FSA) is a cafeteria plan that is funded through salary reductions. Hence the advantage of an FSA to the business owner is its ability to offer additional employment related expenses without expending after-tax dollars to do so since the FSA is funded through employee salary reductions. The salary reduction amounts that the employees use to fund nontaxable benefits under the FSA are not themselves subject to income tax. cpenow.com / [email protected] 36 NPHR/15/01

49 An FSA takes the form of an agreement entered into between an employer and an employee that makes available to the employee a certain level of unspecified non-cash benefits with a pre-determined cash value. Typically the business owner will decide what benefits the FSA will provide and adopts the structure of the FSA to provide those benefits. An FSA must meet all of the rules relating to cafeteria plans that prohibit discrimination in favor of highly compensated employees and prohibit a concentration of plan benefits in the key employees. Generally the benefits that an FSA can provide are the same as for any other cafeteria plan. The basic disadvantage of an FSA is the requirement that employees determine their benefit needs every year and file an election reflecting their deferral amounts annually. Such employees must estimate the amount that will be required for covered expenses at the end of the prior year. There are provisions however for changes due to major life events that would allow an employee to change his or her salary reduction amount and benefit allocation. This disadvantage is compounded by the requirement that unused funds must be forfeited. The Affordable Care Act created a new type of cafeteria plan designed to enable small business to avoid the anti-discrimination rules of 125 that are applicable to regular cafeteria plans. A Simple Cafeteria Plan provides this simplicity with mandated employer contributions, and is only generally available to employers with fewer than 100 employees. For plan years beginning after December 31, 2012, a cafeteria plan may not allow an employee to request salary reduction contributions for a health FSA in excess of $2,500. For plan years beginning after December 31, 2013, the limit is unchanged at $2,500. A cafeteria plan offering a health FSA must be amended to specify the $2,500 limit (or any lower limit set by the employer). While cafeteria plans generally must be amended on a prospective basis, an amendment that is adopted on or before December 31, 2014, may be made effective retroactively, provided that in operation the cafeteria plan meets the limit for plan years beginning after December 31, A cafeteria plan that does not limit health FSA contributions to the dollar limit is not a cafeteria plan and all benefits offered under the plan are includable in the employee's gross income. cpenow.com / [email protected] 37 NPHR/15/01

50 XI. Tax treatment of selected fringe benefits Whether a particular fringe benefit is taxable depends on whether there is a specific statutory exclusion that applies to the benefit. For example, when 61 was amended to include the term fringe benefits, 132 was added to provide exclusions for certain commonly provided fringe benefits that had previously not been addressed in the Internal Revenue Code. Section 132 provides exclusions for working condition fringes, de minimis fringes, no additional cost services, qualified employee discounts, qualified moving expenses, qualified transportation fringes, and qualified retirement planning services. Although it is clear that fringe benefits are taxable, employers may not treat them as wages for income and employment tax purposes. Employers may classify a taxable fringe benefit under expense accounts other than compensation, resulting in a failure to subject the fringe benefit to income and employment taxes. Because the tax treatment of fringe benefits can vary depending on the facts and circumstances under which they are provided, it may be helpful to follow a 3-step analysis when examining a particular item an employer gives or makes available to an executive. First, identify the particular fringe benefit and start with the assumption that its value will be taxable as compensation to the employee. Second, check to see if there are any statutory provisions that exclude the fringe benefit from the executive s gross income. Third, value any portion of the benefit that is not excludable for inclusion in the executive s gross income. Fringe benefits are generally valued at the amount the employee would have to pay for the benefit in an arm s length transaction. There are both income and employment tax issues related to fringe benefits. Is the expense deductible by the corporation? Is the amount excludable from gross income of the executive? Is the executive receiving personal benefit from the corporation? Does the benefit exceed the 162(m) limitation? The following discusses some of the most common fringes and is based on the IRS Publication, Executive Compensation - Fringe Benefits Audit Techniques Guide ( ) and IRS Publication 15-B, Employer's Tax Guide to Fringe Benefits, for use in A. Athletic facility An employer can exclude the value of an employee's use of an on-premises gym or other athletic facility it operates from an employee's wages if substantially all use of the facility during the calendar year is by its employees, their spouses, and their dependent children. For this purpose, an employee's dependent child is a child or stepchild who is the employee's dependent or who, if both parents are deceased, has not attained the age of 25. The athletic facility must be located on premises an employer owns or leases. It does not have to be located on an employer s business premises. However, the exclusion does not apply to an athletic facility for residential use, such as athletic facilities that are part of a resort. cpenow.com / [email protected] 38 NPHR/15/01

51 For purposes of this exclusion, the following individuals are treated as employees: A current employee; A former employee who retired or left on disability; A widow or widower of an individual who died while an employee; A widow or widower of a former employee who retired or left on disability; A leased employee who has provided services to an employer on a substantially full-time basis for at least a year if the services are performed under the employer s primary direction or control; and A partner who performs services for a partnership. B. Athletic skyboxes/cultural entertainment suites In the case of a skybox or other private luxury box leased for more than one event, the amount allowable as a deduction with respect to such events shall not exceed the sum of the face value of a non-luxury box seat ticket(s) for the number of seats in the luxury box. Luxury boxes rented by related parties or individuals are treated as a single lease in determining whether a luxury box is leased for more than one event. The remaining amount for attendance at the event is limited to ordinary and necessary business expenditures that also satisfy all the requirements under: 274(a) directly related to or directly preceding or following a substantial and bona fide business discussion; 274(d) taxpayer substantiates by adequate records or by sufficient evidence corroborating the taxpayer s own statements; or 274(n) 50% limitation. The purchase of a skybox is the purchase of a facility and as such is not deductible. Warning: The IRS will target catered events to verify the 50% limitation has been correctly applied. If the purchased or leased skybox is used personally by the top executives of the corporation, the value of the benefit may be taxable income to the executives. C. Awards and bonuses A business may utilize a number of methods to provide compensation for services rendered by the executives and attempt to disguise the compensatory nature of the payment. The IRS indicates it will closely examine executive payment arrangements and plans used to determine bonuses and or awards. Generally, all payments in whatever form, are payments in the nature of compensation if they arise out of an employment relationship or are associated with the performance of services. Payments in the nature of compensation include (but are not limited to) wages, salary, bonuses, severance pay, fringe benefits, pension benefits and other deferred compensation. The IRS will closely examine awards and /or bonuses paid to key executives to determine if they should be included as remuneration under 162 (m), i.e. excess employee remuneration. D. Employee achievement awards The most that can be excluded from income from employee achievement awards to the same employee for the year is $400. A higher limit of $1,600 applies to qualified plan awards. Qualified plan awards are employee achievement awards under a written plan that does not discriminate in favor of highly cpenow.com / [email protected] 39 NPHR/15/01

52 compensated employees. An award cannot be treated as a qualified plan award if the average cost per recipient of all awards under all of the taxpayer s qualified plans is more than $400. If during the year an employee receives awards not made under a qualified plan and also receives awards under a qualified plan, the exclusion for the total cost of all awards to that employee cannot be more than $1,600. The $400 and $1,600 limits cannot be added together to exclude more than $1,600 for the cost of awards to any one employee during the year. An employer should not withhold federal income, Social Security, or Medicare taxes on the fair market value of an employee achievement award if it is excludable from the employee's gross income. To be excludable from an employee's gross income, the award must be tangible personal property (not cash, gift certificates, or securities) given to an employee for length of service or safety achievement, awarded as part of a meaningful presentation, and awarded under circumstances that do not indicate that the payment is disguised compensation. Excludable employee achievement awards also are not subject to FUTA tax. E. Dependent care assistance This exclusion applies to household and dependent care services an employer directly or indirectly pays for or provides to an employee under a dependent care assistance program that covers only its employees. The services must be for a qualifying person's care and must be provided to allow the employee to work. These requirements are basically the same as the tests the employee would have to meet to claim the dependent care credit if the employee paid for the services. For this exclusion, treat the following individuals as employees: A current employee. A leased employee who has provided services to an employer on a substantially full-time basis for at least a year if the services are performed under the employer s primary direction or control. The individual (if he or she is a sole proprietor). A partner who performs services for a partnership. An employer can exclude the value of benefits it provides to an employee under a dependent care assistance program from the employee's wages if it reasonably believes that the employee can exclude the benefits from gross income. An employee can generally exclude from gross income up to $5,000 of benefits received under a dependent care assistance program each year. This limit is reduced to $2,500 for married employees filing separate returns. However, the exclusion cannot be more than the smaller of the earned income of either the employee or employee's spouse. Special rules apply to determine the earned income of a spouse who is either a student or not able to care for himself or herself. An employer cannot exclude dependent care assistance from the wages of a highly compensated employee unless the benefits provided under the program do not favor highly compensated employees and the program meets the requirements described in 129(d). For this exclusion, a highly compensated employee for 2015 is an employee who meets either of the following tests: 1. The employee was a 5% owner at any time during the year or the preceding year; or 2. The employee received more than $115,000 in pay for the preceding year. cpenow.com / [email protected] 40 NPHR/15/01

53 An employer can ignore test #2 if the employee was not also in the top 20% of employees when ranked by pay for the preceding year. An employer should report the value of all dependent care assistance provided to an employee under a dependent care assistance program in box 10 of the employee's Form W-2. The employer should include any amounts it cannot exclude from the employee's wages in boxes 1, 3, and 5. The employer reports both the nontaxable portion of assistance (up to $5,000) and any assistance above the amount that is taxable to the employee. Example: Company A provides a dependent care assistance flexible spending arrangement to its employees through a cafeteria plan. In addition, it provides occasional on-site dependent care to its employees at no cost. Emily, an employee of company A, had $4,500 deducted from her pay for the dependent care flexible spending arrangement. In addition, Emily used the on-site dependent care several times. The fair market value of the on-site care was $700. Emily's Form W-2 should report $5,200 of dependent care assistance in box 10 ($4,500 flexible spending arrangement plus $700 on-site dependent care). Boxes 1, 3, and 5 should include $200 (the amount in excess of the nontaxable assistance), and applicable taxes should be withheld on that amount. F. Health savings accounts A Health Savings Account (HSA) is an account owned by a qualified individual who is generally an employee or former employee. Any contributions that an employer makes to an HSA become the employee's property and cannot be withdrawn by the employer. Contributions to the account are used to pay current or future medical expenses of the account owner, his or her spouse, and any qualified dependent. The medical expenses must not be reimbursable by insurance or other sources and their payment from HSA funds will not give rise to a medical expense deduction on the individual's federal income tax return. A qualified individual must be covered by a High Deductible Health Plan (HDHP) and not be covered by other health insurance except for permitted insurance listed under 223(c)(3) or insurance for accidents, disability, dental care, vision care, or long-term care. For calendar year 2015, a qualifying HDHP must have a deductible of at least $1,300 for self-only coverage or $2,600 for family coverage and must limit annual out-of-pocket expenses of the beneficiary to $6,450 for self-only coverage and $12,900 for family coverage. There are no income limits that restrict an individual's eligibility to contribute to an HSA nor is there a requirement that the account owner have earned income to make a contribution. An individual is not a qualified individual if he or she can be claimed as a dependent on another person's tax return. Also, an employee's participation in a health flexible spending arrangement (FSA) or health reimbursement arrangement (HRA) generally disqualifies the individual (and employer) from making contributions to his or her HSA. However, an individual may qualify to participate in an HSA if he or she is participating in only a limited-purpose FSA or HRA or a post-deductible FSA. Up to specified dollar limits, cash contributions to the HSA of a qualified individual (determined monthly) are exempt from federal income tax withholding, Social Security tax, Medicare tax, and FUTA tax. For 2015, an employer can contribute up to $3,350 for self-only coverage or $6,650 for family coverage to a qualified individual's HSA. The contribution amounts listed above are increased by $1,000 for a qualified individual who is age 55 or older at any time during the year. For two qualified individuals who are married cpenow.com / [email protected] 41 NPHR/15/01

54 to each other and who each are age 55 or older at any time during the year, each spouse's contribution limit is increased by $1,000 provided each spouse has a separate HSA. No contributions can be made to an individual's HSA after he or she becomes enrolled in Medicare Part A or Part B. An employer s contribution amount to an employee's HSA must be comparable for all employees who have comparable coverage during the same period. Otherwise, there will be an excise tax equal to 35% of the amount the employer contributed to all employees' HSAs. The Tax Relief and Health Care Act of 2006 allows employers to make larger HSA contributions for a nonhighly compensated employee than for a highly compensated employee. A highly compensated employee for 2015 is an employee who meets either of the following tests: 1. The employee was a 5% owner at any time during the year or the preceding year; or 2. The employee received more than $115,000 in pay for the preceding year. An employer can ignore test (2) if the employee was not also in the top 20% of employees when ranked by pay for the preceding year. Partners and 2 percent S corporation shareholders are not eligible for salary reduction contributions to an HSA. Employer contributions to the HSA of a bona fide partner or 2% shareholder are treated as distributions or guaranteed payments as determined by the facts and circumstances. An employer may contribute to an employee's HSA using a cafeteria plan and its contributions are not subject to the statutory comparability rules. However, cafeteria plan nondiscrimination rules still apply. For example, contributions under a cafeteria plan to employee HSAs cannot be greater for higher-paid employees than they are for lower-paid employees. Contributions that favor lower-paid employees are not prohibited. An employer must report its contributions to an employee's HSA in box 12 of Form W-2 using code W. The trustee or custodian of the HSA, generally a bank or insurance company, reports distributions from the HSA using Form 1099-SA, Distributions From an HSA, Archer MSA, or Medicare Advantage MSA. G. Club memberships Section 274(a)(3) provides that a taxpayer may not deduct club dues. This prohibition includes dues for all types of clubs, including social, athletic, sporting, luncheon clubs, airline and hotel clubs and business clubs for all amounts paid or incurred after Regulations (a)(2)(iii) and (e)(3) (ii)(b) clarify that the purposes and activities of a club, and not its name, determine whether it is covered under the disallowance provision. The employer has the choice of either including the value of the club membership in the employee s income or foregoing any deduction for the club dues. Put another way, the company can deduct the cost if it treats the club dues as compensation includable in gross income and wages. However, if the employer s deduction for club dues is disallowed by 274(a)(3), the amount of an employee s working condition fringe benefit relating to the employer-provided membership in the club is determined without regard to the application of 274(a) to the employee. To be excludable as a working condition fringe, however, the amount must otherwise qualify for deduction by the employee under 162(a). Note that the requirements of 274(d) must still be met (i.e., time, place and business purpose must be established). cpenow.com / [email protected] 42 NPHR/15/01

55 The IRS believes that although many businesses are aware of the rule disallowing any deduction for club dues and membership fees, some businesses may try to disguise the nature of the expenditure so as to deduct it. The IRS has noted that employers have given club memberships to departing executives through severance agreements and failed to treat the value of the club membership as wages. The IRS encourages its agents to closely scrutinize employment contracts and severance agreements with departing executives with respect to this issue. H. Business credit cards Many businesses provide corporate credit cards to executives and other employees. The difference between the rank and file credit card accounts and those maintained for executives is generally the method of reimbursement. Top level executives are permitted to use the card at will. A monthly statement may be mailed directly to the corporation and the account may be paid in full without the submission of a business expense report. Lower level executives are generally required to submit an expense report and are reimbursed for business related expenses. Personal expenses paid on behalf of executives are taxable fringe benefits that should be included in wages. In these cases, the IRS will determine whether the corporation has an accountable plan with respect to the top level executives. If these executives are not required to substantiate that the expenses charged to the corporate credit card were for business expenses, the reimbursement is considered to have been made under a non-accountable plan and the entire reimbursement is taxable to the executive, and considered wages for employment tax purposes. I. Executive dining room Meals furnished on the employer s business premises and for the convenience of the employer are excludable from income under 119. In the case of an employer-operated eating facility, the rules of 132(e)(2) must be met in order for the income to be excludable as a de minimis fringe. Section 132(e)(2) provides that the operation by an employer of any eating facility for employees shall be treated as a de minimis fringe if: Such facility is located on or near the business premises of the employer; and Revenue derived from such facility normally equals or exceeds the direct operating costs of such facility. De minimis fringe benefit treatment applies to any highly compensated employee only if access to the facility is available on substantially the same terms to each member of a group of employees which is defined under a reasonable classification set up by the employer which does not discriminate in favor of highly compensated employees. Four tests must be met in order for the value of the meals to be excluded from an employee s gross income: 1. The facility is owned or leased by the employer; 2. The facility is operated by the employer; 3. The facility is located on or near the business premises of the employer; and 4. The meals furnished at the facility are provided during, or immediately before or after, the employee s workday. This income exclusion is available to highly compensated employees only if the direct operating cost test of Regulations (a)(1)(i) is satisfied. This regulation provides that the value of meals provided cpenow.com / [email protected] 43 NPHR/15/01

56 to employees at an employer-operated eating facility for employees is excludable from gross income as a de minimis fringe only if on an annual basis, the revenue from the facility equals or exceeds the direct operating costs of the facility. The nondiscrimination rules under must also be met. For purposes of applying these nondiscrimination rules, a highly compensated employee (HCE) for 2015 is an employee who meets either of the following tests: 1. The employee was a 5% owner at any time during the year or the preceding year; or 2. The employee received more than $115,000 (in 2015) in pay for the preceding year. The employer can choose to ignore the pay test if the employee was not also in the top 20% of employees when ranked by pay for the preceding year. An employer-operated eating facility for employees is a facility that meets all of the following conditions: 1. The facility is owned or leased by the employer; 2. The facility is operated by the employer; 3. The facility is located on or near the business premises of the employer; and 4. The meals furnished at the facility are provided during, or immediately before or after, the employee's workday. The term meals means food, beverages, and related services provided at the facility. If an employer can reasonably determine the number of meals that are excludable from income by the recipient employees under 119, the employer may, in determining whether the requirement of this section is satisfied, disregard all costs and revenues attributable to such meals provided to such employees. If an employer can reasonably determine the number of meals received by volunteers who receive food and beverages at a hospital, free or at a discount, the employer may, in determining whether the requirement of this section is satisfied, disregard all costs and revenues attributable to such meals provided to such volunteers. If an employer charges nonemployees a greater amount than employees, in determining whether the requirement of this section is satisfied, the employer must disregard all costs and revenues attributable to such meals provided to such nonemployees. The direct operating costs test may be applied separately for each dining room or cafeteria. Alternatively, the direct operating costs test may be applied with respect to all the eating facilities operated by the employer. Example: Assume that a not-for-profit hospital system maintains cafeterias for the use of its employees and volunteers. Only the employees are charged for food service at the cafeteria and the policy of the hospital is to charge the employees only for the costs of food, beverage and labor directly attributable to the meal. Most of the cafeterias within the system furnish more free meals to volunteers than they serve paid meals to employees. For purposes of this paragraph, as long as the employer can accurately determine the number of meals received free or at a discount by volunteers, the employer may disregard all the costs and revenues attributable to such meals provided to volunteers. Therefore, for purposes of this paragraph, the costs of the hospital system for furnishing meals to employees who pay for them are the costs to be compared to determine if the revenues from the facility equal or exceed direct operating costs of the facility's service to employees. J. Moving expense reimbursements This exclusion applies to any amount an employer directly or indirectly gives to an employee, (including services furnished in kind) as payment for, or reimbursement of, moving expenses. The employer must cpenow.com / [email protected] 44 NPHR/15/01

57 make the reimbursement under rules similar to those applicable to reimbursement of expenses for travel, meals, and entertainment under accountable plans. The exclusion applies only to reimbursement of moving expenses that the employee could deduct if he or she had paid or incurred them without reimbursement. However, it does not apply if the employee actually deducted the expenses in a previous year. Deductible moving expenses include only the reasonable expenses of: Moving household goods and personal effects from the former home to the new home; and Traveling (including lodging) from the former home to the new home. Deductible moving expenses do not include any expenses for meals and must meet both the distance test and the time test. The distance test is met if the new job location is at least 50 miles farther from the employee's old home than the old job location was. The time test is met if the employee works at least 39 weeks during the first 12 months after arriving in the general area of the new job location. For this exclusion, treat the following individuals as employees: A current employee. A leased employee who has provided services to the employer on a substantially full-time basis for at least a year if the services are performed under the employer s primary direction or control. An employer should not treat a 2% shareholder of an S corporation as an employee of the corporation for this purpose. A 2% shareholder is someone who directly or indirectly owns (at any time during the year) more than 2% of the corporation's stock or stock with more than 2% of the voting power. The employer should treat a 2% shareholder as it would a partner in a partnership for fringe benefit purposes, but do not treat the benefit as a reduction in distributions to the 2% shareholder. Generally, an employer can exclude qualifying moving expense reimbursement it provides to an employee from the employee's wages. If the employer paid the reimbursement directly to the employee, it should report the amount in box 12 of Form W-2 with the code P. Do not report payments to a third party for the employee's moving expenses or the value of moving services provided in kind. K. No-additional-cost services This exclusion applies to a service the employer provides to an employee if it does not cause the employer to incur any substantial additional costs. The service must be offered to customers in the ordinary course of the line of business in which the employee performs substantial services. Generally, no-additional-cost services are excess capacity services, such as airline, bus, or train tickets; hotel rooms; or telephone services provided free or at a reduced price to employees working in those lines of business. To determine whether an employer incurs substantial additional costs to provide a service to an employee, count any lost revenue as a cost. Do not reduce the costs incurred by any amount the employee pays for the service. The employer is considered to incur substantial additional costs if the employer or its employees spends a substantial amount of time in providing the service, even if the time spent would otherwise be idle or if the services are provided outside normal business hours. cpenow.com / [email protected] 45 NPHR/15/01

58 A no-additional-cost service provided to an employee by an unrelated employer may qualify as a noadditional-cost service if all the following tests are met: The service is the same type of service generally provided to customers in both the line of business in which the employee works and the line of business in which the service is provided. The original employer and the employer providing the service have a written reciprocal agreement under which a group of employees of each employer, all of whom perform substantial services in the same line of business, may receive no-additional-cost services from the other employer. Neither employer incurs any substantial additional cost either in providing the service or because of the written agreement. For this exclusion, treat the following individuals as employees: 1. A current employee. 2. A former employee who retired or left on disability. 3. A widow or widower of an individual who died while an employee. 4. A widow or widower of a former employee who retired or left on disability. 5. A leased employee who has provided services to the employer on a substantially full-time basis for at least a year if the services are performed under the employer s primary direction or control. 6. A partner who performs services for a partnership. The employer should treat services it provides to the spouse or dependent child of an employee as provided to the employee. For this fringe benefit, dependent child means any son, stepson, daughter, or stepdaughter who is a dependent of the employee, or both of whose parents have died and who has not reached age 25. Treat a child of divorced parents as a dependent of both parents. Treat any use of air transportation by the parent of an employee as use by the employee. This rule does not apply to use by the parent of a person considered an employee because of item (3) or (4) above. An employer can generally exclude the value of a no-additional-cost service provided to an employee from the employee's wages. An employer cannot exclude from the wages of a highly compensated employee the value of a no-additional-cost service that is not available on the same terms to one of the following groups: All employees; or A group of employees defined under a reasonable classification the employer set up that does not favor highly compensated employees. For this exclusion, a highly compensated employee for 2015 is an employee who meets either of the following tests. 1. The employee was a 5% owner at any time during the year or the preceding year; or 2. The employee received more than $115,000 in pay for the preceding year. An employer can choose to ignore test (2) if the employee was not also in the top 20% of employees when ranked by pay for the preceding year. cpenow.com / [email protected] 46 NPHR/15/01

59 L. Retirement planning services An employer may exclude from an employee's wages the value of any retirement planning advice or information it provides to its employee or his or her spouse if it maintains a qualified retirement plan as defined in 219(g)(5). In addition to employer plan advice and information, the services provided may include general advice and information on retirement. However, the exclusion does not apply to services for tax preparation, accounting, legal, or brokerage services. An employer cannot exclude from the wages of a highly compensated employee retirement planning services that are not available on the same terms to each member of a group of employees normally provided education and information about the employer's qualified retirement plan. Section 132(a)(7) excludes from gross income qualified retirement planning services. The services are defined in 132(m) as any retirement planning advice or information provided to an employee and his spouse by an employer maintaining a qualified employer plan. The employer may not discriminate in favor of highly compensated executives. The nondiscrimination rule states that the exclusion is allowable for highly compensated employees only if the retirement planning services are available on substantially the same terms to each member of the group of employees normally provided education and information regarding the employer s qualified employer plan (which is defined as a plan, contract, pension or account described in 219(g)(5)). For the purposes of CIC taxpayers, this would be stock bonus, pension or profit sharing plans with a qualified trust, not the executive s nonqualified deferred compensation. The IRS identifies this issue by requesting information about services provided by the company to the executives for income tax preparation, financial planning, or other accounting services. A review of the executive s employment agreements and benefits will also assist in identifying this issue. A cursory review of the corporation s outside accounting expense account(s) may lead to identification of this issue. M. De minimis transportation benefits An employer can exclude the value of any de minimis transportation benefit it provides to an employee from the employee's wages. A de minimis transportation benefit is any local transportation benefit an employer provides to an employee if it has so little value (taking into account how frequently the employer provides transportation to its employees) that accounting for it would be unreasonable or administratively impracticable. For example, it applies to occasional transportation fare an employer gives an employee because the employee is working overtime if the benefit is reasonable and is not based on hours worked. For this exclusion, treat any recipient of a de minimis transportation benefit as an employee. This exclusion applies to the following benefits: A ride in a commuter highway vehicle between the employee's home and work place; A transit pass; Qualified parking; and Qualified bicycle commuting reimbursement. The exclusion applies whether an employer provides only one or a combination of these benefits to its employees. cpenow.com / [email protected] 47 NPHR/15/01

60 Qualified transportation benefits can be provided directly by an employer or through a bona fide reimbursement arrangement. However, cash reimbursements for transit passes qualify only if a voucher or a similar item that the employee can exchange only for a transit pass is not readily available for direct distribution by an employer to its employee. A voucher is readily available for direct distribution only if an employee can obtain it from a voucher provider that does not impose fare media charges or other restrictions that effectively prevent the employer from obtaining vouchers. Generally, an employer can exclude qualified transportation fringe benefits from an employee's wages even if the employer provides them in place of pay. However, qualified bicycle commuting reimbursements cannot be excluded if the reimbursements are provided in place of pay. A commuter highway vehicle is any highway vehicle that seats at least 6 adults (not including the driver). In addition, the employer must reasonably expect that at least 80% of the vehicle mileage will be for transporting employees between their homes and work place with employees occupying at least one-half the vehicle's seats (not including the driver's). A transit pass is any pass, token, fare card, voucher, or similar item entitling a person to ride, free of charge or at a reduced rate, on one of the following: On mass transit. In a vehicle that seats at least 6 adults (not including the driver) if a person in the business of transporting persons for pay or hire operates it. Mass transit may be publicly or privately operated and includes bus, rail, or ferry. Qualified parking is parking an employer provides to its employees on or near its business premises. It includes parking on or near the location from which the employer s employees commute to work using mass transit, commuter highway vehicles, or carpools. It does not include parking at or near the employee's home. For any calendar year, the exclusion for qualified bicycle commuting reimbursement includes any employer reimbursement during the 15-month period beginning with the first day of the calendar year for reasonable expenses incurred by the employee during the calendar year. Reasonable expenses include: The purchase of a bicycle; and Bicycle improvements, repair, and storage. These are considered reasonable expenses as long as the bicycle is regularly used for travel between the employee's residence and place of employment. For this exclusion, treat the following individuals as employees: A current employee; or A leased employee who has provided services to an employer on a substantially full-time basis for at least a year if the services are performed under the employer s primary direction or control. A self-employed individual is not an employee for qualified transportation benefit purposes. An employer should not treat a 2% shareholder of an S corporation as an employee of the corporation for this purpose. A 2% shareholder is someone who directly or indirectly owns (at any time during the year) cpenow.com / [email protected] 48 NPHR/15/01

61 more than 2% of the corporation's stock or stock with more than 2% of the voting power. An employer should treat a 2% shareholder as it would a partner in a partnership for fringe benefit purposes, but do not treat the benefit as a reduction in distributions to the 2% shareholder. An employer cannot exclude a qualified transportation benefit it provides to an employee under the de minimis or working condition benefit rules. However, if it provides a local transportation benefit other than by transit pass or commuter highway vehicle, or to a person other than an employee, it may be able to exclude all or part of the benefit under other fringe benefit rules (de minimis, working condition, etc.). An employer can generally exclude the value of transportation benefits that it provides to an employee during 2015 from the employee's wages up to the following limits: $130 per month for combined commuter highway vehicle transportation and transit passes. $250 per month for qualified parking. For a calendar year, $20 multiplied by the number of qualified bicycle commuting months during that year for qualified bicycle commuting reimbursement of expenses incurred during the year. For any employee, a qualified bicycle commuting month is any month the employee: N. Tuition reduction Regularly uses the bicycle for a substantial portion of the travel between the employee's residence and place of employment; and Does not receive: o Transportation in a commuter highway vehicle; o Any transit pass; or o Qualified parking benefits. An educational organization can exclude the value of a qualified tuition reduction it provides to an employee from the employee's wages. A tuition reduction for undergraduate education generally qualifies for this exclusion if it is for the education of one of the following individuals: 1. A current employee. 2. A former employee who retired or left on disability. 3. A widow or widower of an individual who died while an employee. 4. A widow or widower of a former employee who retired or left on disability. 5. A dependent child or spouse of any individual listed in (1) through (4) above. A tuition reduction for graduate education qualifies for this exclusion only if it is for the education of a graduate student who performs teaching or research activities for the educational organization. cpenow.com / [email protected] 49 NPHR/15/01

62 O. Working condition benefits This exclusion applies to property and services an employer provides to an employee so that the employee can perform his or her job. It applies to the extent the employee could deduct the cost of the property or services as a business expense or depreciation expense if he or she had paid for it. The employee must meet any substantiation requirements that apply to the deduction. Examples of working condition benefits include an employee's use of a company car for business, an employer-provided cell phone provided primarily for noncompensatory business purposes, and job-related education provided to an employee. This exclusion also applies to a cash payment an employer provides for an employee's expenses for a specific or prearranged business activity for which a deduction is otherwise allowable to the employee. An employer must require the employee to verify that the payment is actually used for those expenses and to return any unused part of the payment. The exclusion does not apply to the following items: A service or property provided under a flexible spending account in which an employer agrees to provide the employee, over a time period, a certain level of unspecified noncash benefits with a predetermined cash value. A physical examination program the employer provides, even if mandatory. Any item to the extent the employee could deduct its cost as an expense for a trade or business other than the employer s trade or business. For this exclusion, treat the following individuals as employees: A current employee. A partner who performs services for a partnership. A director of the employer company. An independent contractor who performs services for the employer. 1. Employer-provided vehicles If an employer provides a car for an employee's use, the amount an employer can exclude as a working condition benefit is the amount that would be allowable as a deductible business expense if the employee paid for its use. If the employee uses the car for both business and personal use, the value of the working condition benefit is the part determined to be for business use of the vehicle. However, instead of excluding the value of the working condition benefit, an employer can include the entire annual lease value of the car in the employee's wages. The employee can then claim any deductible business expense for the car as an itemized deduction on his or her personal income tax return. This option is available only if the employer uses the lease value rule to value the benefit. All of an employee's use of a qualified nonpersonal use vehicle is a working condition benefit. A qualified nonpersonal use vehicle is any vehicle the employee is not likely to use more than minimally for personal purposes because of its design. Qualified nonpersonal use vehicles generally include all of the following vehicles: Clearly marked, through painted insignia or words, police, fire, and public safety vehicles. Unmarked vehicles used by law enforcement officers if the use is officially authorized. An ambulance or hearse used for its specific purpose. cpenow.com / [email protected] 50 NPHR/15/01

63 Any vehicle designed to carry cargo with a loaded gross vehicle weight over 14,000 pounds. Delivery trucks with seating for the driver only, or the driver plus a folding jump seat. A passenger bus with a capacity of at least 20 passengers used for its specific purpose. School buses. Tractors and other special-purpose farm vehicles. Bucket trucks, cement mixers, combines, cranes and derricks, dump trucks (including garbage trucks), flatbed trucks, forklifts, qualified moving vans, qualified specialized utility repair trucks, and refrigerated trucks. A pickup truck with a loaded gross vehicle weight of 14,000 pounds or less is a qualified nonpersonal use vehicle if it has been specially modified so it is not likely to be used more than minimally for personal purposes. For example, a pickup truck qualifies if it is clearly marked with permanently affixed decals, special painting, or other advertising associated with the employer s trade, business, or function and meets either of the following requirements. It is equipped with at least one of the following items: o A hydraulic lift gate; o Permanent tanks or drums; o Permanent side boards or panels that materially raise the level of the sides of the truck bed; or o Other heavy equipment (such as an electric generator, welder, boom, or crane used to tow automobiles and other vehicles). It is used primarily to transport a particular type of load (other than over the public highways) in a construction, manufacturing, processing, farming, mining, drilling, timbering, or other similar operation for which it was specially designed or significantly modified. A van with a loaded gross vehicle weight of 14,000 pounds or less is a qualified nonpersonal use vehicle if it has been specially modified so it is not likely to be used more than minimally for personal purposes. For example, a van qualifies if it is clearly marked with permanently affixed decals, special painting, or other advertising associated with the employer s trade, business, or function and has a seat for the driver only (or the driver and one other person) and either of the following items: Permanent shelving that fills most of the cargo area; or An open cargo area and the van always carries merchandise, material, or equipment used in the trade, business, or function. 2. Education provided by an employer Certain job-related education an employer provides to an employee may qualify for exclusion as a working condition benefit. To qualify, the education must meet the same requirements that would apply for determining whether the employee could deduct the expenses had the employee paid the expenses. Degree programs as a whole do not necessarily qualify as a working condition benefit. Each course in the program must be evaluated individually for qualification as a working condition benefit. The education must meet at least one of the following tests: The education is required by the employer or by law for the employee to keep his or her present salary, status, or job. The required education must serve a bona fide business purpose of the employer. The education maintains or improves skills needed in the job. cpenow.com / [email protected] 51 NPHR/15/01

64 However, even if the education meets one or both of the above tests, it is not qualifying education if it: 3. Educational assistance Is needed to meet the minimum educational requirements of the employee's present trade or business; or Is part of a program of study that will qualify the employee for a new trade or business. This exclusion applies to educational assistance an employer provides to employees under an educational assistance program. The exclusion also applies to graduate level courses. Educational assistance means amounts an employer pays or incurs for its employees' education expenses. These expenses generally include the cost of books, equipment, fees, supplies, and tuition. However, these expenses do not include the cost of a course or other education involving sports, games, or hobbies, unless the education: Has a reasonable relationship to the employer s business; or Is required as part of a degree program. Education expenses do not include the cost of tools or supplies (other than textbooks) the employee is allowed to keep at the end of the course. Nor do they include the cost of lodging, meals, or transportation. An educational assistance program is a separate written plan that provides educational assistance only to an employer s employees. The program qualifies only if all of the following tests are met. The program benefits employees who qualify under rules set up by the employer that do not favor highly compensated employees. To determine whether the employer s program meets this test, do not consider employees excluded from an employer s program who are covered by a collective bargaining agreement if there is evidence that educational assistance was a subject of good-faith bargaining. The program does not provide more than 5% of its benefits during the year for shareholders or owners. A shareholder or owner is someone who owns (on any day of the year) more than 5% of the stock or of the capital or profits interest of the business. The program does not allow employees to choose to receive cash or other benefits that must be included in gross income instead of educational assistance. The employer gives reasonable notice of the program to eligible employees. An employer s program can cover former employees if their employment is the reason for the coverage. For this exclusion, a highly compensated employee for 2015 is an employee who meets either of the following tests: 1. The employee was a 5% owner at any time during the year or the preceding year; or 2. The employee received more than $115,000 in pay for the preceding year. An employer can ignore test (2) if the employee was not also in the top 20% of employees when ranked by pay for the preceding year. For this exclusion, an employer treats the following individuals as employees: A current employee. A former employee who retired, left on disability, or was laid off. cpenow.com / [email protected] 52 NPHR/15/01

65 A leased employee who has provided services to the employer on a substantially full-time basis for at least a year if the services are performed under the employer s primary direction or control. The individual if he or she is a sole proprietor. A partner who performs services for a partnership. An employer can exclude up to $5,250 of educational assistance an employer provides to an employee under an educational assistance program from the employee's wages each year. If an employer does not have an educational assistance plan, or it provides an employee with assistance exceeding $5,250, the employer must include the value of these benefits as wages, unless the benefits are working condition benefits. Working condition benefits may be excluded from wages. Property or a service provided is a working condition benefit to the extent that if the employee paid for it, the amount paid would have been deductible as a business or depreciation expense. 4. Outplacement services An employee's use of outplacement services qualifies as a working condition benefit if the employer provides the services to the employee on the basis of need, the employer gets a substantial business benefit from the services distinct from the benefit it would get from the payment of additional wages, and the employee is seeking employment in the same trade or business of the employer. Substantial business benefits include promoting a positive business image, maintaining employee morale, and avoiding wrongful termination suits. Outplacement services do not qualify as a working condition benefit if the employee can choose to receive cash or taxable benefits in place of the services. If the employer maintains a severance plan and permits employees to get outplacement services with reduced severance pay, include in the employee's wages the difference between the unreduced severance and the reduced severance payments. An employer can generally exclude the value of a working condition benefit it provides to an employee from the employee's wages. cpenow.com / [email protected] 53 NPHR/15/01

66 P. Employer-provided auto In most cases, an employer must use the general valuation rule to value a fringe benefit. However, an employer may be able to use a special valuation rule to determine the value of certain benefits. Under the general valuation rule, the value of a fringe benefit is its fair market value. The fair market value (FMV) of a fringe benefit is the amount an employee would have to pay a third party in an arm's-length transaction to buy or lease the benefit. An employer should determine this amount on the basis of all the facts and circumstances. Neither the amount the employee considers to be the value of the fringe benefit nor the cost the employer incurs to provide the benefit determines its FMV. In general, the FMV of an employer-provided vehicle is the amount the employee would have to pay a third party to lease the same or similar vehicle on the same or comparable terms in the geographic area where the employee uses the vehicle. A comparable lease term would be the amount of time the vehicle is available for the employee's use, such as a 1-year period. An employer should not determine the FMV by multiplying a cents-per-mile rate times the number of miles driven unless the employee can prove the vehicle could have been leased on a cents-per-mile basis. Under the cents-per-mile rule, an employer determines the value of a vehicle an employer provides to an employee for personal use by multiplying the standard mileage rate by the total miles the employee drives the vehicle for personal purposes. Personal use is any use of the vehicle other than use in the employer s trade or business. This amount must be included in the employee's wages or reimbursed by the employee. For 2015, the standard mileage rate is 57.5 cents per mile. An employer can use the cents-per-mile rule if either of the following requirements is met: The employer reasonably expects the vehicle to be regularly used in its trade or business throughout the calendar year (or for a shorter period during which the employer owns or leases it); or The vehicle meets the mileage test. An employer cannot use the cents-per-mile rule for an automobile (any four-wheeled vehicle, such as a car, pickup truck, or van) if its value when the employer first makes it available to any employee for personal use is more than an amount determined by the IRS as the maximum automobile value for the year. For example, an employer cannot use the cents-per-mile rule for an automobile that the employer first made available to an employee in 2015 if its value at that time exceeded $16,000 for a passenger automobile or $17,500 for a truck or van. For the cents-per-mile rule, a vehicle is any motorized wheeled vehicle, including an automobile, manufactured primarily for use on public streets, roads, and highways. A vehicle is regularly used in an employer s trade or business if at least one of the following conditions is met: At least 50% of the vehicle's total annual mileage is for the employer s trade or business. The employer sponsors a commuting pool that generally uses the vehicle each workday to drive at least three employees to and from work. The vehicle is regularly used in the employer s trade or business on the basis of all of the facts and circumstances. Infrequent business use of the vehicle, such as for occasional cpenow.com / [email protected] 54 NPHR/15/01

67 trips to the airport or between an employer s multiple business premises, is not regular use of the vehicle in an employer s trade or business. A vehicle meets the mileage test for a calendar year if both of the following requirements are met: The vehicle is actually driven at least 10,000 miles during the year. If an employer owns or leases the vehicle only part of the year, reduce the 10,000 mile requirement proportionately. The vehicle is used during the year primarily by employees. Consider the vehicle used primarily by employees if they use it consistently for commuting. Do not treat the use of the vehicle by another individual whose use would be taxed to the employee as use by the employee. For example, if only one employee uses a vehicle during the calendar year and that employee drives the vehicle at least 10,000 miles in that year, the vehicle meets the mileage test even if all miles driven by the employee are personal. If an employer uses the cents-per-mile rule, the following requirements apply. The employer must begin using the cents-per-mile rule on the first day the employer makes the vehicle available to any employee for personal use. However, if an employer uses the commuting rule (discussed later) when it first makes the vehicle available to any employee for personal use, the employer can change to the cents-per-mile rule on the first day for which it does not use the commuting rule. The employer must use the cents-per-mile rule for all later years in which it makes the vehicle available to any employee and the vehicle qualifies, except that it can use the commuting rule for any year during which use of the vehicle qualifies under the commuting rules. However, if the vehicle does not qualify for the cents-per-mile rule during a later year, the employer can use for that year and thereafter any other rule for which the vehicle then qualifies. The employer must continue to use the cents-per-mile rule if it provides a replacement vehicle to the employee (and the vehicle qualifies for the use of this rule) and the employer s primary reason for the replacement is to reduce federal taxes. The cents-per-mile rate includes the value of maintenance and insurance for the vehicle. The employer should not reduce the rate by the value of any service included in the rate that it did not provide. For miles driven in the United States, its territories and possessions, Canada, and Mexico, the cents-per-mile rate includes the value of fuel the employer provides. If the employer does not provide fuel, it can reduce the rate by no more than 5.5 cents. Under the commuting rule, an employer can determine the value of a vehicle it provides to an employee for commuting use by multiplying each one-way commute (that is, from home to work or from work to home) by $1.50. If more than one employee commutes in the vehicle, this value applies to each employee. This amount must be included in the employee's wages or reimbursed by the employee. An employer can use the commuting rule if all the following requirements are met: The employer provided the vehicle to an employee for use in its trade or business and, for bona fide noncompensatory business reasons, the employer requires the employee to commute in the vehicle. The employer will be treated as if it had met this requirement if cpenow.com / [email protected] 55 NPHR/15/01

68 the vehicle is generally used each workday to carry at least three employees to and from work in an employer-sponsored commuting pool. The employer establishes a written policy under which it does not allow the employee to use the vehicle for personal purposes other than for commuting or de minimis personal use (such as a stop for a personal errand on the way between a business delivery and the employee's home). Personal use of a vehicle is all use that is not for the employer s trade or business. The employee does not use the vehicle for personal purposes other than commuting and de minimis personal use. If this vehicle is an automobile (any four-wheeled vehicle, such as a car, pickup truck, or van), the employee who uses it for commuting is not a control employee. A control employee of a nongovernment employer for 2015 is generally any of the following employees: A board or shareholder-appointed, confirmed, or elected officer whose pay is $105,000 or more. A director. An employee whose pay is $215,000 or more. An employee who owns a 1% or more equity, capital, or profits interest in the employer s business. Instead of using the preceding definition, an employer can choose to define a control employee as any highly compensated employee. A highly compensated employee for 2015 is an employee who meets either of the following tests: 1. The employee was a 5% owner at any time during the year or the preceding year; or 2. The employee received more than $115,000 in pay for the preceding year. An employer can choose to ignore test (2) if the employee was not also in the top 20% of employees when ranked by pay for the preceding year. Under the lease value rule, an employer determines the value of an automobile it provides to an employee by using its annual lease value. For an automobile provided only part of the year, the employer can use either its prorated annual lease value or its daily lease value. If the automobile is used by the employee in the employer s business, the employer can generally reduce the lease value by the amount that is excluded from the employee's wages as a working condition benefit. In order to do this, the employee must account to the employer for the business use. This is done by substantiating the usage (mileage, for example), the time and place of the travel, and the business purpose of the travel. Written records made at the time of each business use are the best evidence. Any use of a company-provided vehicle that is not substantiated as business use is included in income. The working condition benefit is the amount that would be an allowable business expense deduction for the employee if the employee paid for the use of the vehicle. However, an employer can choose to include the entire lease value in the employee's wages. If an employer uses the lease value rule, the following requirements apply: The employer must begin using this rule on the first day it makes the automobile available to any employee for personal use. However, the following exceptions apply. cpenow.com / [email protected] 56 NPHR/15/01

69 o o If an employer uses the commuting rule (discussed earlier) when it first makes the automobile available to any employee for personal use, it can change to the lease value rule on the first day for which it does not use the commuting rule. If an employer uses the cents-per-mile rule (discussed earlier in this section) when it first makes the automobile available to any employee for personal use, it can change to the lease value rule on the first day on which the automobile no longer qualifies for the cents-per-mile rule. An employer must use this rule for all later years in which it makes the automobile available to any employee, except that the employer can use the commuting rule for any year during which use of the automobile qualifies. The employer must continue to use this rule if it provides a replacement automobile to the employee and its primary reason for the replacement is to reduce federal taxes. Generally, an employer figures the annual lease value of an automobile as follows: 1. Determine the fair market value (FMV) of the automobile on the first date it is available to any employee for personal use. 2. Using Table 1. Annual Lease Value Table, (See IRS Publication 15-B) read down column (1) until coming to the dollar range within which the FMV of the automobile falls. Then read across to column (2) to find the annual lease value. 3. Multiply the annual lease value by the percentage of personal miles out of total miles driven by the employee. The FMV of an automobile is the amount a person would pay to buy it from a third party in an arm'slength transaction in the area in which the automobile is bought or leased. That amount includes all purchase expenses, such as sales tax and title fees. If an employer has 20 or more automobiles, see Regulations (d)(5)(v). cpenow.com / [email protected] 57 NPHR/15/01

70 Q. Group-term life insurance This exclusion applies to life insurance coverage that meets all the following conditions. It provides a general death benefit that is not included in income. The employer provides it to a group of employees. It provides an amount of insurance to each employee based on a formula that prevents individual selection. This formula must use factors such as the employee's age, years of service, pay, or position. The employer provides it under a policy the employer directly or indirectly carries. Even if the employer does not pay any of the policy's cost, the employer is considered to carry it if it arranges for payment of its cost by its employees and charges at least one employee less than, and at least one other employee more than, the cost of his or her insurance. Group-term life insurance does not include the following insurance: Insurance that does not provide general death benefits, such as travel insurance or a policy providing only accidental death benefits. Life insurance on the life of an employee's spouse or dependent. However, an employer may be able to exclude the cost of this insurance from the employee's wages as a de minimis benefit. Insurance provided under a policy that provides a permanent benefit (an economic value that extends beyond 1 policy year, such as paid-up or cash surrender value), unless certain requirements are met. For this exclusion, the employer must treat the following individuals as employees: 1. A current common-law employee. 2. A full-time life insurance agent who is a current statutory employee. 3. An individual who was formerly the employer s employee under (1) or (2). 4. A leased employee who has provided services to the employer on a substantially full-time basis for at least a year if the services are performed under the employer s primary direction and control. An employer should not treat a 2% shareholder of an S corporation as an employee of the corporation for this purpose. A 2% shareholder is someone who directly or indirectly owns (at any time during the year) more than 2% of the corporation's stock or stock with more than 2% of the voting power. Treat a 2% shareholder as a partner in a partnership for fringe benefit purposes, but do not treat the benefit as a reduction in distributions to the 2% shareholder. Generally, life insurance is not group-term life insurance unless an employer provides it to at least 10 fulltime employees at some time during the year. For this rule, count employees who choose not to receive the insurance unless, to receive it, they must contribute to the cost of benefits other than the group-term life insurance. For example, count an employee who could receive insurance by paying part of the cost, even if that employee chooses not to receive it. However, do not count an employee who must pay part or all of the cost of permanent benefits to get insurance, unless that employee chooses to receive it. A permanent benefit is an economic value extending beyond one policy year (for example, a paid-up or cash-surrender value) that is provided under a life insurance policy. cpenow.com / [email protected] 58 NPHR/15/01

71 Even if an employer does not meet the 10-employee rule, two exceptions allow an employer to treat insurance as group-term life insurance. Under the first exception, an employer does not have to meet the 10-employee rule if all the following conditions are met: 1. If evidence that the employee is insurable is required, it is limited to a medical questionnaire (completed by the employee) that does not require a physical. 2. The employer provides the insurance to all its full-time employees or, if the insurer requires the evidence mentioned in (1), to all full-time employees who provide evidence the insurer accepts. 3. The employer figures the coverage based on either a uniform percentage of pay or the insurer's coverage brackets that meet certain requirements. Under the second exception, an employer does not have to meet the 10-employee rule if all the following conditions are met: The employer provides the insurance under a common plan covering its employees and the employees of at least one other employer who is not related to the employer. The insurance is restricted to, but mandatory for, all the employer s employees who belong to, or are represented by, an organization (such as a union) that carries on substantial activities besides obtaining insurance. Evidence of whether an employee is insurable does not affect an employee's eligibility for insurance or the amount of insurance that employee gets. To apply either exception, do not consider employees who were denied insurance for any of the following reasons: They were 65 or older. They customarily work 20 hours or less a week or 5 months or less in a calendar year. They have not been employed for the waiting period given in the policy. This waiting period cannot be more than 6 months. An employer can generally exclude the cost of up to $50,000 of group-term life insurance from the wages of an insured employee. An employer can exclude the same amount from the employee's wages when figuring Social Security and Medicare taxes. In addition, the employer does not have to withhold federal income tax or pay FUTA tax on any group-term life insurance the employer provides to an employee. An employer must include in its employee's wages the cost of group-term life insurance beyond $50,000 worth of coverage, reduced by the amount the employee paid toward the insurance. Report it as wages in boxes 1, 3, and 5 of the employee's Form W-2. Also, show it in box 12 with code C. The amount is subject to Social Security and Medicare taxes, and the employer may, at its option, withhold federal income tax. The employer should figure the monthly cost of the insurance to include in the employee's wages by multiplying the number of thousands of dollars of all insurance coverage over $50,000 (figured to the nearest $100) by the cost shown in the table below. For all coverage provided within the calendar year, the employer should use the employee's age on the last day of the employee's tax year. The employer must prorate the cost from the table if less than a full month of coverage is involved. cpenow.com / [email protected] 59 NPHR/15/01

72 Cost Per $1,000 of Protection for 1 Month Age Cost Under 25 $ through through through through through through through through through and older 2.06 The employer should figure the total cost to include in the employee's wages by multiplying the monthly cost by the number of full months' coverage at that cost. Example: Tom's employer provides him with group-term life insurance coverage of $200,000. Tom is 45 years old, is not a key employee, and pays $100 per year toward the cost of the insurance. Tom's employer must include $170 in his wages. The $200,000 of insurance coverage is reduced by $50,000. The yearly cost of $150,000 of coverage is $270 ($.15 x 150 x 12), and is reduced by the $100 Tom pays for the insurance. The employer includes $170 in boxes 1, 3, and 5 of Tom's Form W-2. The employer also enters $170 in box 12 with code C. Group-term life insurance coverage paid by the employer for the spouse or dependents of an employee may be excludable from income as a de minimis fringe benefit if the face amount is not more than $2,000. If the face amount is greater than $2,000, the entire cost of the dependent coverage must be included in income unless the amount over $2,000 is purchased with employee contributions on an after-tax basis. The cost of the insurance is determined by using the table above. When group-term life insurance over $50,000 is provided to an employee (including retirees) after his or her termination, the employee share of Social Security and Medicare taxes on that period of coverage is paid by the former employee with his or her tax return and is not collected by the employer. The employer is not required to collect those taxes. The former employer can use the table above to determine the amount of Social Security and Medicare taxes owed by the former employee for coverage provided after separation from service. The former employer will report those uncollected amounts separately in box 12 of Form W-2 using codes M and N. See the General Instructions for Forms W-2 and W-3 and the Instructions for Form 941. Generally, if an employer s group-term life insurance plan favors key employees as to participation or benefits, the employer must include the entire cost of the insurance in its key employees' wages. This exception generally does not apply to church plans. When figuring Social Security and Medicare taxes, the employer must also include the entire cost in the employees' wages. Include the cost in boxes 1, 3, cpenow.com / [email protected] 60 NPHR/15/01

73 and 5 of Form W-2. However, the employer does not have to withhold federal income tax or pay FUTA tax on the cost of any group-term life insurance it provides to an employee. For this purpose, the cost of the insurance is the greater of the following amounts: The premiums paid for the employee's insurance. See Regulations T(Q&A 6) for more information. The cost the employer figures using the above table. For this exclusion, a key employee during 2015 is an employee or former employee who is one of the following individuals: An officer having annual pay of more than $170,000. An individual who for 2015 was either of the following: o A 5% owner of the employer s business; or o A 1% owner of the employer s business whose annual pay was more than $150,000. A former employee who was a key employee upon retirement or separation from service is also a key employee. An employer s plan does not favor key employees as to participation if at least one of the following is true: It benefits at least 70% of its employees; At least 85% of the participating employees are not key employees; or It benefits employees who qualify under a set of rules the employer set up that do not favor key employees. An employer s plan meets this participation test if it is part of a cafeteria plan and it meets the participation test for those plans. When applying this test, the employer does not consider employees who: Have not completed 3 years of service; Are part-time or seasonal; Are nonresident aliens who receive no U.S. source earned income from the employer; or Are not included in the plan but are in a unit of employees covered by a collective bargaining agreement, if the benefits provided under the plan were the subject of goodfaith bargaining between the employer and employee representatives. An employer s plan does not favor key employees as to benefits if all benefits available to participating key employees are also available to all other participating employees. An employer s plan does not favor key employees just because the amount of insurance the employer provides to its employees is uniformly related to their pay. Because an employer cannot treat a 2% shareholder of an S corporation as an employee for this exclusion, the employer must include the cost of all group-term life insurance coverage it provides the 2% shareholder in his or her wages. When figuring Social Security and Medicare taxes, the employer must also include the cost of this coverage in the 2% shareholder's wages. The employer should include the cost in boxes 1, 3, and 5 of Form W-2. However, the employer does not have to withhold federal income tax or pay federal unemployment tax on the cost of any group-term life insurance coverage it provides to the 2% shareholder. cpenow.com / [email protected] 61 NPHR/15/01

74 1. Spousal/dependent life insurance Group term life insurance premiums paid to insure the lives of a spouse or dependent of an executive are generally included in the gross income of the executive. Group-term life insurance coverage paid by the employer for the spouse or dependents of an employee may be excludable from income as a de minimis fringe benefit if the face amount is not more than $2,000. If the face amount is greater than $2,000, the entire cost of the dependent coverage must be included in income unless the amount over $2,000 is purchased with employee contributions on an after-tax basis. The cost of dependent group term life insurance must be determined under Table I of (d)(2) of the regulations. Employers attempt to classify such payments as a de minimis fringe benefit; however, the IRS takes a very narrow view of this provision (PLR ). R. Employee stock options There are three kinds of stock options incentive stock options, employee stock purchase plan options, and nonstatutory (nonqualified) stock options. Wages for Social Security, Medicare, and federal unemployment (FUTA) taxes do not include remuneration resulting from the exercise, after October 22, 2004, of an incentive stock option or under an employee stock purchase plan option, or from any disposition of stock acquired by exercising such an option. The IRS will not apply these taxes to an exercise before October 23, 2004, of an incentive stock option or an employee stock purchase plan option or to a disposition of stock acquired by such exercise. Additionally, federal income tax withholding is not required on the income resulting from a disqualifying disposition of stock acquired by the exercise after October 22, 2004, of an incentive stock option or under an employee stock purchase plan option, or on income equal to the discount portion of stock acquired by the exercise, after October 22, 2004, of an employee stock purchase plan option resulting from any disposition of the stock. The IRS will not apply federal income tax withholding upon the disposition of stock acquired by the exercise, before October 23, 2004, of an incentive stock option or an employee stock purchase plan option. However, the employer must report as income in box 1 of Form W-2, (i) the discount portion of stock acquired by the exercise of an employee stock purchase plan option upon disposition of the stock; and (ii) the spread (between the exercise price and the fair market value of the stock at the time of exercise) upon a disqualifying disposition of stock acquired by the exercise of an incentive stock option or an employee stock purchase plan option. An employer must report the excess of the fair market value of stock received upon exercise of a nonstatutory stock option over the amount paid for the stock option on Form W-2 in boxes 1, 3 (up to the Social Security wage base), 5, and in box 12 using the code V. See Regulations An employee who transfers his or her interest in nonstatutory stock options to the employee's former spouse incident to a divorce is not required to include an amount in gross income upon the transfer. The former spouse, rather than the employee, is required to include an amount in gross income when the former spouse exercises the stock options. S. Loans to employees Businesses may loan or extend credit to their executives at no cost or low cost. In some instances, the terms are such that the loan is really disguised compensation to the executive. Factors that are indicative of a bona fide loan are: Existence of a promissory note; cpenow.com / [email protected] 62 NPHR/15/01

75 Cash payments according to a specified repayment schedule; Interest is charged; and There is security for the loan. The IRS will review loans made to executives to determine if they are bona fide and to determine if the terms are being followed. Issues include whether there is a written document detailing the terms of the loan and addressing such issues as: Payment over a certain number of years or payment on demand; Is the interest rate at market or at a below market rate of interest; Is the loan listed on the company s balance sheet as a receivable; and Are the terms of the loan being followed, are payments to be made monthly, and is the executive not making payments, etc. The loan terms could include forgiveness of part or the entire loan if the executive remains with the company for a certain number of years, etc. Section 7872 deals generally with the treatment of loans with below market interest rates and specifically to compensation-related loans. Such loans include below market loans directly or indirectly between an employer and an employee. In general, 7872 operates to impute interest on below market loans. In the case of employer/employee loans, the employer is treated as transferring the foregone interest to the employee as additional compensation and the employee is treated as paying interest back to the employer. Different rules apply depending on whether a loan is a demand loan (7827(a)) or a term loan (7872(b)). A demand loan is a below market loan if it does not provide for an interest rate at least equal to the applicable federal rate. A term loan is a below market loan if the present value of all amounts due on the loan is less than the amount of the loan (i.e., the yield to maturity is lower than the applicable federal rate). With respect to demand loans, the imputed interest payments and deemed transfer of additional compensation are treated as being made annually. With respect to term loans, the lender is treated at the time of the loans as transferring the difference between the loan amount and the present value of all the future payments under the loan as additional compensation. The term loan is then treated as having original issue discount equal to the amount of the deemed transfer of additional compensation and, thus, subject to the original issue discount provisions of There is a de minimis exception from the application of the 7872 imputation rules if loans between the parties in aggregate do not exceed $10,000. The de minimis exception does not apply if one of the principal purposes of the loan is tax avoidance. Some loans to executives are essentially disguised compensation based on the terms of the loan. Sections 61(a)(1) and 61(a)(12) define gross income to include compensation for services and income from discharge of indebtedness. Reg (a) provides that if an individual performs services for a creditor, who in consideration for the services, cancels the debt, the debtor realizes income in the amount of the debt as compensation for services. Discharge of indebtedness income by an employee from an employer under these circumstances is payment in the nature of compensation, and thus is includable in gross income and wages for employment tax purposes. In general, if an employer lends an employee more than $10,000 at an interest rate less than the current applicable federal rate (AFR), the difference between the interest paid and the interest that would be paid cpenow.com / [email protected] 63 NPHR/15/01

76 under the AFR is considered additional compensation to the employee. This rule applies to a loan of $10,000 or less if one of its principal purposes is the avoidance of federal tax. This additional compensation to the employee is subject to Social Security, Medicare, and FUTA taxes, but not to federal income tax withholding. Include it in compensation on Form W-2 (or Form 1099-MISC for an independent contractor). The AFR is established monthly and published by the IRS each month in the Internal Revenue Bulletin. T. Qualified employee discounts This exclusion applies to a price reduction an employer gives an employee on property or services it offers to customers in the ordinary course of the line of business in which the employee performs substantial services. However, it does not apply to discounts on real property or discounts on personal property of a kind commonly held for investment (such as stocks or bonds). For this exclusion, an employer treats the following individuals as employees: A current employee. A former employee who retired or left on disability. A widow or widower of an individual who died while an employee. A widow or widower of an employee who retired or left on disability. A leased employee who has provided services to an employer on a substantially full-time basis for at least a year if the services are performed under the employer s primary direction or control. A partner who performs services for a partnership. Section 132(c)(4) provides an exclusion for a price reduction an employer gives an executive on qualified property or services offered to customers in the ordinary course of the line of business in which the employee performs substantial service. The exclusions are as follows: For a discount on services, 20% of the price the employer charges nonemployee customers for the service. For a discount on merchandise or other property, the employer s gross profit percentage times the price charged nonemployee customers for the property. The employer determines its gross profit percentage in the line of business based on all property it offers to customers (including employee customers) and its experience during the tax year immediately before the tax year in which the discount is available. The employer should figure its gross profit percentage by subtracting the total cost of the property from the total sales price of the property and divide the result by the total sales price of the property. The exclusion does not apply to discounts on real property or discounts on personal property of a kind commonly held for investment (such as stocks and bonds) and no discounts are allowed for directors and independent contractors. The IRS has noted that it is quite common for former officers to be retained on a contractual basis by the corporation upon retirement who continue to receive discounts even though such discounts on a tax-excluded basis are not allowed. Qualified employee discounts must be provided on a nondiscriminatory basis. An employer cannot exclude from the wages of a highly compensated employee any part of the value of a discount that is not available on the same terms to one of the following groups: cpenow.com / [email protected] 64 NPHR/15/01

77 All employees; or A group of employees defined under a reasonable classification the employer set up that does not favor highly compensated employees. For this exclusion, a highly compensated employee for 2015 is an employee who meets either of the following tests: 1. The employee was a 5% owner at any time during the year or the preceding year; or 2. The employee received more than $115,000 in pay for the preceding year. An employer can choose to ignore test (2) if the employee was not also in the top 20% of employees when ranked by pay for the preceding year. U. Security-related transportation Regulations (m)(1) provides that if a bona fide business-oriented security concern exists, and an overall security program exists, then the employee may exclude the excess of the value of the transportation provided by the employer over the amount that the employee would have paid for the same mode of transportation absent the bona fide security concern. With respect to air transportation, the phrase same mode of transportation means comparable air transportation. A bona fide business-oriented security concern exists only if the facts and circumstances establish a specific basis for concern regarding the safety of the executive. A generalized concern for the executive s safety will not trigger application of the security exclusion. The employer must demonstrate the existence of a bona fide security concern. A bona fide security concern exists if the facts and circumstances demonstrate a specific basis for concern regarding the safety of the employee. Examples of specific bases for a bona fide security concern include a specific threat to harm the employee or a recent history of violent terrorist activity in the geographic area in which the transportation is provided. An overall security program must be established. In order to establish the existence of an overall security program, the employer must generally establish that security is provided to the employee on a 24-hour basis. However, an overall security program is deemed to exist if the following conditions are satisfied: A security study is performed with respect to the employer and the employee (or a similarly situated employee of the employer) by an independent security consultant; The security study is based on an objective assessment of all facts and circumstances; The recommendation of the security study is that an overall security program is not necessary and the recommendation is reasonable under the circumstances; and The employer applies the specific security recommendations contained in the security study to the employee on a consistent basis. An independent security study could conclude, for example, that security during air travel is necessary, but security on a 24-hour basis is unnecessary. The expenses incurred for security services will normally be deducted under Other Deductions. The IRS directs its examining agents to review Forms W-2/1099 and employment agreements as they may provide information related to security services. The IRS has found upon examination that homes of executives have been fortified with special rooms or other security devices. It is important to evaluate the level of security afforded top executives and their families to determine that security studies are being followed. cpenow.com / [email protected] 65 NPHR/15/01

78 V. Employer-provided meals An employer can exclude any occasional meal or meal money it provides to an employee if it has so little value (taking into account how frequently the employer provides meals to its employees) that accounting for it would be unreasonable or administratively impracticable. The exclusion applies, for example, to the following items: Coffee, doughnuts, or soft drinks. Occasional meals or meal money provided to enable an employee to work overtime. However, the exclusion does not apply to meal money figured on the basis of hours worked. Occasional parties or picnics for employees and their guests. This exclusion also applies to meals the employer provides at an employer-operated eating facility for employees if the annual revenue from the facility equals or exceeds the direct costs of the facility. For this purpose, an employer s revenue from providing a meal is considered equal to the facility's direct operating costs to provide that meal if its value can be excluded from an employee's wages. If food or beverages an employer furnishes to employees qualify as a de minimis benefit, the employer can deduct their full cost. The 50% limit on deductions for the cost of meals does not apply. For this exclusion, an employer should treat any recipient of a de minimis meal as an employee. An employer-operated eating facility for employees is an eating facility that meets all the following conditions: The employer owns or leases the facility. The employer operates the facility. The employer is considered to operate the eating facility if it has a contract with another to operate it. The facility is on or near the employer s business premises. The employer provides meals (food, drinks, and related services) at the facility during, or immediately before or after, the employee's workday. An employer can generally exclude the value of de minimis meals it provides to an employee from the employee's wages. The employer cannot exclude from the wages of a highly compensated employee the value of a meal provided at an employer-operated eating facility that is not available on the same terms to one of the following groups: All of the employees; or A group of employees defined under a reasonable classification the employer sets up that does not favor highly compensated employees. For this exclusion, a highly compensated employee for 2015 is an employee who meets either of the following tests: 1. The employee was a 5% owner at any time during the year or the preceding year; or 2. The employee received more than $115,000 in pay for the preceding year. The employer can choose to ignore test (2) if the employee was not also in the top 20% of employees when ranked by pay for the preceding year. cpenow.com / [email protected] 66 NPHR/15/01

79 The employer can exclude the value of meals it furnishes to an employee from the employee's wages if they meet the following tests: They are furnished on the employer s business premises. They are furnished for the employer s convenience. This exclusion does not apply if the employer allows its employee to choose to receive additional pay instead of meals. Generally, for this exclusion, the employee's place of work is its business premises. Whether an employer furnishes meals for its convenience as an employer depends on all the facts and circumstances. An employer furnishes the meals to its employee for its convenience if it does this for a substantial business reason other than to provide the employee with additional pay. This is true even if a law or an employment contract provides that the meals are furnished as pay. However, a written statement that the meals are furnished for the employer s convenience is not sufficient. If more than half of an employer s employees who are furnished meals on its business premises are furnished the meals for the employer s convenience, the employer can treat all meals it furnishes to employees on its business premises as furnished for its convenience. Meals an employer furnishes to a restaurant or other food service employee during, or immediately before or after, the employee's working hours are furnished for the employer s convenience. For example, if a waitress works through the breakfast and lunch periods, an employer can exclude from her wages the value of the breakfast and lunch furnished to her in the employer s restaurant for each day she works. Meals an employer furnishes during working hours are furnished for an employer s convenience if the employee could not otherwise eat proper meals within a reasonable period of time. For example, meals can qualify for this treatment if there are insufficient eating facilities near the place of employment. Meals an employer furnishes to an employee immediately after working hours are furnished for an employer s convenience if the employer would have furnished them during working hours for a substantial nonpay business reason but, because of the work duties, they were not eaten during working hours. Meals an employer furnishes to promote goodwill, boost morale, or attract prospective employees are not considered furnished for the employer s convenience. Such meals may also be able to be excluded as de minimis meals. An employer generally cannot exclude from an employee's wages the value of meals the employer furnishes on a day when the employee is not working. However, an employer can exclude these meals if they are furnished with lodging that is excluded from the employee's wages as earlier discussed. The fact that an employer charges for the meals and that the employees may accept or decline the meals is not taken into account in determining whether or not meals are furnished for the employer s convenience. For this exclusion, do not treat a 2% shareholder of an S corporation as an employee of the corporation. A 2% shareholder is someone who directly or indirectly owns (at any time during the year) more than 2% of the corporation's stock or stock with more than 2% of the voting power. Treat a 2% shareholder as a cpenow.com / [email protected] 67 NPHR/15/01

80 partnership would a partner in a partnership for fringe benefit purposes, but do not treat the benefit as a reduction in distributions to the 2% shareholder. cpenow.com / [email protected] 68 NPHR/15/01