2012 Regional Forums. Employee Benefits & Employment Taxes. Mark H. Misselbeck, C.P.A., M.S.T. Katz, Nannis + Solomon, P.C.

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1 EMPLOYEE BENEFITS 1. Federal Tax Day - Current, L.1, Code Sec. 119: Meals Provided to Airline Employees While on Duty Were Excluded From Gross Income (CCA ), (Dec. 28, 2011) 2011 Thomson Reuters/RIA. All rights reserved 2. IRS Letter Rulings and TAMS (Current), UIL No Certain fringe benefits; Working condition fringe. UIL No Definitions; Wages. UIL No Definitions; Wages; Non-business wages. UIL No Definitions; Wages; Supplemental unemployment benefit plans. IRS Letter Ruling (Sep. 22, 2011), Internal Revenue Service,(Sep. 22, 2011) 2011 Thomson Reuters/RIA. All rights reserved EMPLOYMENT TAXES 3. Federal Tax Day - Current, J.2, S Corporation Liable for Employment Taxes; Workers Were Employees, Not Contractors; Penalties Imposed (Atlantic Coast Masonry, Inc., TCM), (Aug. 14, 2012) 2012 Thomson Reuters/RIA. All rights reserved. 4. Tax Court Regulars (Current), Hershal Weber v. Commissioner., U.S. Tax Court, CCH Dec. 59,048, 138 T.C. No. 18, (May 7, 2012) 2012 Thomson Reuters/RIA. All rights reserved. 5. Federal Tax Day - Current, J.3, Minister Was Responsible Person Liable for Unpaid Payroll Taxes; First Amendment Rights to Freedom of Religion and Establishment Clause Not Violated (Vaughn, DC N.C.),(Jul. 30, 2012) 2012 Thomson Reuters/RIA. All rights reserved.

2 EMPLOYEE BENEFITS 1. Federal Tax Day - Current, L.1, Code Sec. 119: Meals Provided to Airline Employees While on Duty Were Excluded From Gross Income (CCA ), (Dec. 28, 2011) The value of catered meals provided to airline crew members while they performed their flight duties was excludable from their gross income. The meals were prepared by an independent vendor for crew members since they were required to remain on the aircraft while they performed their flight duties. Although the meals were provided for a substantial noncompensatory business reason and excludable from the employees gross incomes, the employer s deduction was limited to 50 percent of the amount expended for the meals and beverages under Code Sec. 274(n). However, the meals were not excludable as de minimis fringe benefits under Code Sec. 132(e)(2) since the meals were not provided at the employer s eating facility. CCA Letter Ruling Other References: Code Sec. 119 o CCH Reference FED Tax Research Consultant o CCH Reference TRC COMPEN: 36,502 Chief Counsel Advice Memorandum, UIL No Meals or lodging furnished for convience of employer (Excluded v. not excluded). UIL No Certain fringe benefits; De minimus fringe; Certain eating facilities. IRS Letter Ruling (Aug. 31, 2011), Internal Revenue Service,(Aug. 31, 2011) LTR , August 31, 2011 Symbol: CC: TEGE: EOEG: ET:2-POSTU Uniform Issue List Nos , [Code Secs. 119 and 132] Meals or lodging furnished for convience of employer (Excluded v. not excluded); Certain fringe benefits; De minimus fringe; Certain eating facilities. DATE: August 31, 2011

3 TO: James L. May, Jr., Senior Attorney, Office of Chief Counsel (Large Business & International) FROM: Lynne Camillo, Chief, Employment Tax Branch 2, Division Counsel/Associate Chief Counsel (Tax Exempt & Government Entities) SUBJECT: Employer-Provided Eating Facilities This Chief Counsel Advice responds to your request for assistance. This advice may not be used or cited as precedent. This memorandum responds to your inquiry concerning whether the value of certain employer-provided meals are excludable from employees' gross incomes under section 132(e)(2). ISSUE May crew members exclude the value of catered meals that Taxpayer provides them while they perform their flight duties from their gross incomes under section 132(e) of the Internal Revenue Code (the Code)? CONCLUSION The meals are not excludable under section 132(e) of the Code because they are not provided at an eating facility. FACTS Taxpayer provides catered meals on its ***** planes for crew members to eat while they are performing their flight duties. The meals are prepared by an independent third party vendor at a facility on the ground. The facility is not owned, leased, or operated by the employer. The crew has to report for duty at least one hour prior to their flight and remain at least 30 minutes after the flight, possibly due to safety checks. During the pre-flight/inflight/post-flight time period, the crew is not allowed to leave the plane. The amount of food provided to the crew is dependent upon the time period, which the employer refers to as Duty Time, during which the crew must remain on the plane: beverages provided regardless of duration (coffee, water, juice, etc.) domestic flights with the Duty Time exceeding ***** hours = 1 in-flight snack domestic flights with the Duty Time exceeding ***** hours = 1 in-flight meal domestic flights with the Duty Time exceeding ***** hours = 2 in-flight meals international flights with the Duty Time exceeding ***** hours = 1 in-flight snack

4 international flights with the Duty Time exceeding ***** hours = 1 in-flight meal international flights with the Duty Time exceeding ***** hours = 2 in-flight meals The planes have limited seating areas at which crew members may consume the meals. Photographs provided to the IRS indicate that the only such areas are the seats that are located on or near the flight deck (namely, a seat for the pilot(s) and possibly a jump seat). The IRS proposed an adjustment to the amount that Taxpayer deducted for expenses incurred providing meals to its flight crews. Taxpayer took a full deduction, and the IRS proposed limiting the deduction to 50 percent of the expenses incurred based on section 274(n)(1), which limits the amount allowed as a deduction for food or beverages to 50 percent of the expenses incurred. Taxpayer disputed the adjustment, arguing that the meals were excluded from the limitation by way of 274(n)(2)(B), which excepts food or beverages from the 50 percent limitation if they qualify as de minimis fringe benefits under section 132(e). Taxpayer seeks to deduct expenses attributable to meals in the amounts of $***** for Year 1, $***** for Year 2, and $***** for Year 3. LAW Section 61(a)(1) of the Code provides that gross income includes compensation for services, including fringe benefits, except as otherwise provided. Section 119(a) of the Code allows an employee to exclude the value of any meals furnished by or on behalf of his employer if the meals are furnished on the employer's business premise for the convenience of the employer. Section (a)(1) of the income tax regulations states that the question of whether meals are furnished for the convenience of the employer is one of fact to be determined by analysis of all the facts and circumstances in each case. Section (a)(2)(i) of the income tax regulations provides meals furnished by an employer without charge to the employee will be regarded as furnished for the convenience of the employer if such meals are furnished for a substantial noncompensatory business reason of the employer. Section (a)(2)(ii)(b) of the income tax regulations provides that meals will be regarded as furnished for a substantial noncompensatory business reason of the employer if the meals are furnished to the employee during the employee's working hours because the employer's business is such that the employee must be restricted to a short meal period, such as 30 or 45 minutes, and because the employee could not be expected to eat elsewhere in such a short meal period. Section (a)(2)(ii)(c) of the income tax regulations provides that meals will be regarded as furnished for a substantial noncompensatory business reason of the employer if the meals are furnished to the employee during the employee's working hours because the employee could not otherwise secure proper meals within a reasonable meal period. Section 119(b)(4) of the Code provides that if the employer furnishes meals to employees at the employer's place of business and the employer furnishes the meals to more than half of the employees for the convenience of the employer, the meals furnished to all employees will also be regarded as furnished for the convenience of the

5 employer. Section 132(a)(4) of the Code excludes from gross income any fringe benefit which qualifies as a de minimis fringe. Section 132(e)(2) of the Code provides that the value of meals provided to employees at an employeroperated eating facility is an excludable de minimis fringe benefit if the revenue derived from the facility normally equals or exceeds the direct operating costs of the facility. Section (a)(2) of the income tax regulations provides that in determining if the revenues derived from the facility normally equal or exceed the direct operating costs of the facility, the employer can disregard the costs and revenues attributable to meals provided that can be reasonably determined to be excludable under section 119 of the Code. For Taxpayer's eating facility to qualify as a de minimis fringe benefit, the facility must meet each of the requirements under section 132(e)(2) of the Code. Namely, this subsection provides that the term de minimis fringe includes the operation by an employer of any eating facility for employees if (A) such facility is located on or near the business premises of the employer, and (B) revenue derived from such facility normally equals or exceeds the direct operating costs of such facility. However, the above sentence applies with respect to a highly compensated employee only if access to the facility is available on substantially the same terms to each member of a group of employees that is defined under a reasonable classification set up by the employer that does not discriminate in favor of highly compensated employees. Section 162(a) of the Code allows a deduction for the ordinary and necessary expenses paid or incurred in carrying on any trade or business, including the expenses of traveling away from home. The value of meals qualifying for the exclusion of section 119 ordinarily is deductible by the employer as a compensation expense under section 162. An amount otherwise deductible under section 162(a) may be subject to disallowance or limitation by section 274. Under Section 274(n), the deduction is limited, as a general rule, to 50 percent of the amount expended for meals or beverages. Section 274(n)(2) of the Code, however, sets forth several exceptions to section 274(n)(1). Section 274(n)(2)(B) allows a full deduction for an expense for food or beverages if such expense is excludable from the gross income of the recipient under section 132 by reason of subsection (e) thereof (relating to de minimis fringes). ANALYSIS Although it appears that the meals are excludable from crew members' gross incomes under section 119 of the Code, they are not excludable under section 132 of the Code. Taxpayer may therefore deduct only 50 percent of the costs associated with providing the meals. In particular, the limited information we have indicates that Taxpayer is indeed likely to be able to sustain its burden of establishing that the meals satisfy the requirements of section 119. First, it appears that the meals satisfy the requirement of section 119 that the meals be provided to employees by or on behalf of Taxpayer; the meals are provided, to this end, by a third party vendor with whom Taxpayer has entered into a contract. It also appears that the meals provided meet the requirement of section 119 that Taxpayer provide them on its business premises; that is, the meals are provided on the airplanes on which the employees provide services to Taxpayer. Finally, the facts

6 and circumstances indicate that the meals meet the requirement of section 119 that they are provided for a substantial noncompensatory business reason ; namely, crew members must remain on the airplanes during their meal periods. What is ultimately at issue in this matter is the extent to which Taxpayer can deduct the costs it incurs to provide its employees with food and beverages. Although the Taxpayer is entitled to deduct these costs as trade or business expenses under section 162, section 274(n) limits the extent of this deduction. Namely, section 274(n)(1) limits the Taxpayer's deduction to 50 percent of these costs. The expenses are excepted from this 50 percent limitation if they are excludable as de minimis fringe benefits under section 132(e). The conclusion that these meals are excludable under section 119 is not dispositive of the issue of whether they are excludable under section 132(e). The legislative history of section 274(n) clarifies that the 50 percent limitation applies even to expenses associated with meals that are excludable under section 119. H.R. Conf. Rep specifies that the 50 percent limitation applies to the amount of any deduction otherwise allowable for meal expenses, including meals furnished on an employer's premises to its employees (whether or not such meals are excludable from the employee's gross incomes under sec. 119). This conference report further indicates that Congress did not intend for this limitation to apply to meals excludable only under section 119 when it stated that the exception to the limitation applied only to: (1) reimbursed meal expenses (in which case the employer or person making the reimbursement is subject to the 80-percent rule); (2) employer-furnished meals that are excludable from the employee's gross income as de minimis fringes under Code section 132(e) (including meals at certain eating facilities excludable under sec. 132(e)(2)); (3) meals fully taxed to the recipient as compensation; and (4) items sold to the public (such as expenses incurred by restaurants or dinner theaters for food or entertainment provided to their customers), or furnished to the public as samples or for promotion (such as expenses incurred by a hotel in furnishing complimentary lodging to potential customers). In sum, this conference committee report specifies both that the 50 percent limitation applies to provision of meals that are excludable only under section 119, and that the provision of meals must satisfy the particular requirements of section 132(e)(2) to be exempted from this 50 percent limitation. Taxpayer asserts that the costs are, indeed, excludable under section 132(e)(2). The Ninth Circuit's decision in Boyd Gaming Corp. v. Comm'r, 177 F.3d 1096 (9th Cir. 1999) [99-1 USTC 50,530], lends some support to this argument. The court held in Boyd that an employer-provided meal meets the revenue/direct operating cost test of section 132(e)(2) if the employee could exclude the value of that meal under section 119. As noted above, it appears that employees could exclude the value of the majority if not all of the meals at issue in the present matter under section 119. These meals therefore meet the revenue/direct operating cost test of section 132(e)(2). It is important to note, however, that Boyd is distinguishable from the instant incase insofar as the meals in Boyd were provided at a cafeteria on the employer's business premises. That the meals are excludable under section 119 does not, however, mean that they necessarily qualify for exclusion under section 132(e)(2). To conclude that any meal that meets the revenue/direct operating cost test of

7 section 132(e)(2) by virtue of being excludable under section 119 is a de minimis fringe benefit would effectively nullify the status of section 119 as a stand-alone exclusion. That is, because employer-provided meals that meet the requirements of section 132(e) are fully deductible, while those that meet the requirements of section 119 are only partially deductible, taxpayers would always exclude the meals under section 132(e). Congress did not intend this result. When Congress amended the Code to include the exception for de minimis fringe benefits in the Deficit Reduction Act of 1984, it explicitly indicated that it did not intend to alter the reach of section 119 when it stated in the House Report that accompanied the amendment that, Free meals provided on an employer's premises to employees for the convenience of the employer are excludable from income to the extent provided by present-law section 119, which is not amended by this bill. (emphasis added). When Congress codified Boyd Gaming in 1997, it similarly indicated that the provision of a meal does not qualify for exclusion under section 132 merely by virtue of qualifying for exclusion under section 119 when it stated, in the Conference Committee report that accompanied the amending of section 132(e), that meals that are excludable from employees' incomes because they are provided for the convenience of the employer pursuant to section 119 of the Code are excludable as a de minimis fringe benefit and therefore are fully deductible by the employer, provided that they satisfy the relevant section 132 requirements. (emphasis added). Among the requirements of section 132(e) is that the employer provide the meal at an eating facility. Namely, on its face, section 132(e)(2) does not exclude from recipients' gross incomes the value of all employer-provided meals that meet the revenue/operating cost test of section 132(e)(2); rather, this exclusion extends only to such meals provided at employer-operated eating facilities. Although the Code, Regulations, and cases never explicitly define the term eating facility, they do imply that an eating facility means an identifiable location that is designated for the preparation and/or consumption of meals. To this end, describing the requirements of meeting the 132(e)(2) exclusion, section of the Tax Regulations refers to dining rooms ( see Treas. Reg (a)(1)(ii) ( each dining room in which meals are served is treated as a separate eating facility ); Treas. Reg (b)(ii) ( direct operating costs test may be applied separately for each dining room )) and cafeterias ( see Treas. Reg (a)(1)(ii) ( each cafeteria in which meals are served is treated is a separate eating facility ); Treas. Reg (b)(ii) ( direct operating costs test may be applied separately for each cafeteria ); Treas. Reg (a)(4) Ex. 1 ( Assume that a not-for-profit hospital system maintains cafeterias for the use of its employees and volunteers )). Further, the regulations contemplate that an eating facility is a location at which individuals are employed to prepare and/or serve food, stating to this end that components of the direct operating costs of an eating facility include personnel whose services relating to the facility are performed on the premises of the eating facility (Treas. Reg (b)(ii)) and labor costs attributable to cooks, waiters, and waitresses. (Treas. Reg (b)(ii)). No guidance raises the inference that the exclusion of section 132(e) extends to all meals provided on the employer's business premises, irrespective of whether or not they are provided at an eating facility. CONCLUSION The employer-provided meals at issue in this matter are not excludable as de minimis fringe benefits under section 132(e)(2) of the Code because they are not provided at eating facilities. This writing may contain privileged information. Any unauthorized disclosure of this writing may undermine our ability to protect the privileged information. If disclosure is determined to be necessary, please contact this office for our views. Please contact me at (202) if you have any further questions.

8 2. IRS Letter Rulings and TAMS (Current), UIL No Certain fringe benefits; Working condition fringe. UIL No Definitions; Wages. UIL No Definitions; Wages; Non-business wages. UIL No Definitions; Wages; Supplemental unemployment benefit plans. IRS Letter Ruling (Sep. 22, 2011), Internal Revenue Service,(Sep. 22, 2011) LTR , September 22, 2011 Symbol: CC: TEGE: EOEG: ET2-PLR Uniform Issue List Nos , , , [Code Secs. 132 and 3121] Certain fringe benefits; Working condition fringe; Definitions; Wages; Definitions; Wages; Non-business wages; Definitions; Wages; Supplemental unemployment benefit plans. This is in response to your letter dated March 23, 2011, requesting a ruling that certain insurance premium payments made by and on behalf of employees, and certain benefit payments made to employees, under the Insurance Plan are not subject to employment taxes. FACTS Taxpayer's employees may participate in the Insurance Plan. At issue in this ruling request are the tax consequences of premium payments made, and benefit payments received, pursuant to two participation options. The first participation option (Option 1) is available to employees with less than two years of service. Employees participating in the Insurance Plan under this option will voluntarily make premium payments with their own aftertax dollars. The amounts of these premium payments will be based on prevailing market rates and the experience rating attributable to the individual's employment. These employees will have the option to request that Taxpayer withhold these premium payments from their paychecks. The second participation option (Option 2) is available to certain employees with two or more years of service. Taxpayer will make premium payments on behalf of employees who participate in the Insurance Plan under this option. Benefit payments received by employees under either Option 1 or 2 will supplement State A's public unemployment insurance benefits and will allow the employees, or Taxpayer, to purchase insurance which together with the state unemployment benefits covers 50 percent of the insured's wages. Participants in the Insurance Plan are entitled to benefit payments only if they are eligible for benefits under state A's public unemployment insurance plan. The Plan further restricts and modifies benefit payments in the following ways: (1) Only individuals who are involuntarily unemployed from full-time employment are entitled to benefit

9 payments; (2) An unemployed person who starts working part-time after starting to receive unemployment benefits, and therefore suffers a reduction in his benefits, will be treated under the Insurance Plan as unemployed and will receive the same amount of benefits as the individual received before he started the part-time work; and (3) The Insurance Plan will not provide benefit payments to an individual who has lost the covered employment due to illness or disability. Benefit payments under the Insurance Plan will be paid periodically and will begin after the individual has received unemployment benefits for two weeks. Plan benefits will cease at the earlier of the cessation of State A benefits or 24 weeks of payments under the Insurance Plan. RULINGS REQUESTED (1) Unemployment insurance purchased by employees with after-tax dollars under the Insurance Plan does not constitute a taxable employer-provided benefit for the employees, (2) Unemployment insurance premium payments purchased on behalf of employees by the Taxpayer under the Insurance Plan are excluded from gross income as working condition fringe benefits under section 132(d) of the code, and (3) Unemployment insurance benefit payments received by employees, deriving from premium payments purchased by Taxpayer on behalf of those employees, are not wages subject to taxes imposed under the Federal Insurance Contributions Act (FICA) and the Federal Unemployment Tax Act (FUTA). LAW 1. Payments Subject to Employment Taxes For purposes of this ruling, the term employment taxes means the FICA tax imposed on employers and employees, the FUTA tax imposed on employers, and federal Income Tax Withholding (ITW). Employers withhold and pay employment taxes on wages they pay to their employees. Sections 3101 and 3111 of the Code impose FICA taxes on wages, as that term is defined in section 3121(a), with respect to employment, as that term is defined in section 3121(b). FICA taxes consist of the Old-Age, Survivors and Disability Insurance tax (social security tax) and the Hospital Insurance tax (Medicare tax). These taxes are imposed on both the employer and employee. Sections 3101(a) and 3101(b) impose the employee portions of the social security tax and the Medicare tax, respectively. Sections 3111(a) and 3111(b) impose the employer portions of the social security tax and the Medicare tax, respectively. Section 3121(a) of the Code defines wages for FICA purposes as all remuneration for employment, with certain specific exceptions. Section 3121(b) defines the term employment as any service, of whatever nature, performed by an employee for the person employing him, with certain specific exceptions.

10 Section (a)-1(b) of the Employment Tax Regulations provides that the term wages means all remuneration for employment unless specifically excepted under section 3121(a). Section (a)-1(c) provides that the name by which the remuneration for employment is designated is immaterial. Salaries, fees, and bonuses are wages, if paid as compensation for employment. Section (a)-1(d) provides that generally the basis upon which the remuneration is paid is immaterial in determining whether the remuneration is wages. Section (b)-3(b) defines employment as services performed by an employee for an employer, unless specifically excepted under section 3121(b). The FUTA taxation provisions are similar to the FICA provisions, except that only the employer pays the tax imposed under FUTA. See sections 3301 and 3306(b) and the regulations thereunder. Although there are differences in the statutory exceptions to what constitutes wages and employment, the general definitions of the terms wages and employment for FUTA purposes are similar to the definitions for FICA purposes. See sections 3306(b) and 3306(c). Section 3402(a), relating to ITW, generally requires every employer making a payment of wages to deduct and withhold upon those wages a tax determined in accordance with prescribed tables or computational procedures. The term wages is defined in section 3401(a) for ITW purposes as all remuneration for services performed by an employee for his employer, with certain specific exceptions. Section (a)-1(a)(2) of the Employment Tax Regulations provides that the name by which remuneration for services is designated is immaterial. Thus, salaries, fees and bonuses are wages if paid as compensation for services performed by the employee for his employer. Section (a)-1(a)(3) provides that generally the basis upon which the remuneration is paid is immaterial in determining whether the remuneration is wages. Unlike the FICA and the FUTA, the ITW provisions do not include a definition of employment. 2. Working Condition Fringe Benefits Section 61(a) of the Code defines gross income as, unless otherwise excluded, all income from whatever source derived, including (but not limited to) compensation for services such as fees, commissions, fringe benefits, and similar items. Section (a) of the Income Tax Regulations provides that gross income includes income derived in any form, whether in money, property, or services. Section (a)(1) of the regulations provides that a fringe benefit may include, for example, an employer-provided discount on property or services. Section (b) of the regulations provides that an employee must include in gross income the amount by which the fair market value of an item exceeds the amount, if any, paid for the benefit by or on behalf of the recipient. Under section (b)(2), the fair market value of a benefit is the amount that an individual would have to pay for the particular fringe benefit in an arm's length transaction. Section 132(a)(3) of the Code excludes from gross income any fringe benefit that qualifies as a working condition fringe. Section 132(d) defines the term working condition fringe as any property or services provided by an employer to an employee to the extent that, if the employee paid for the property or services, the payment would be allowable as a deduction under section 162 (ordinary and necessary trade or business expenses) or section 167 (concerning depreciation). Section (a)(1)(iii) of the regulations provides that an amount that would be deductible by an employee under a section other than section 162 or 167, such as section 212, is not a working condition fringe.

11 Section 162(a) of the Internal Revenue Code allows a taxpayer to deduct all ordinary and necessary business expenses paid or incurred during the tax year in carrying on any trade or business. It has long been recognized that an employee is engaged in the business of being an employee, and that an expense which is essential to the continuance of the employment is deductible for income tax purposes. Noland v. Commissioner, 269 F.2d 108 (4th Cir. 1959) [59-2 USTC 9600]; Schmidlapp v. Commissioner, 96 F.2d 680 (2nd Cir. 1938) [38-1 USTC 9285]. Furthermore, an employee is engaged in the trade or business of performing services as an employee separate and apart from the performance of those services for his existing employer. Motto v. Commissioner, 54 T.C. 558 (1970) [CCH Dec. 30,013]; Primuth v. Commissioner, 54 T.C. 374 (1970) [CCH Dec. 29,985]; Rev. Rul , C.B. 55. Because an employee's trade or business exists apart from the employee's performance of services for one particular employer, expenses that an employee incurs in seeking new employment in the same trade or business are deductible, as are expenses an employee incurs in suing a former employer for wrongful termination. Rev. Rul , supra; Biehl v. Commissioner, 118 T.C. 467 (2002) [CCH Dec. 54,760], affd. 351 F.3d 982 (9th Cir. 2003). Rev. Rul , C.B. 52, considered whether contributions by employees to private plans for payment of non-occupation disability benefits under the New Jersey Temporary Disability Benefits Law are deductible business expenses. In reaching the conclusion that the expenses are not deductible business expenses, but are rather nondeductible personal expenses, that ruling concluded that: Amounts paid by employees to fund private plans for the payment of disability benefits are not paid or accrued in carrying on a trade or business because they are incurred to provide indemnity coverage for loss of wages due to unemployment from nonoccupational hazards rather than from business hazards. The nonoccupational personal nature of the benefit aspect of the private disability plans makes the contributions to the private plans nondeductible personal expenses under section 262 of the Code. Section (a)(2)(i) of the Income Tax Regulations clarifies that it not sufficient for the property or service to merely be deductible under section 162 of the Code for that property or service to constitute a working condition fringe. Rather, the property or service must be allowable as a deduction under section 162 with respect to the employee's specific trade or business of being an employee of the employer. Thus, not all expenses deductible by the employee under section 162 will meet this standard. See the examples section (a)(2)(ii) of the Income Tax Regulations. Revenue Ruling 92-69, C.B. 51, provides that this requirement is generally satisfied if, under all the facts and circumstances, (1) the employer derives a substantial business benefit from the provision of the property or services that is distinct from the benefit that it would derive from the mere payment of additional compensation, and (2) the employee's hypothetical payment for the property or services would otherwise be allowable as a deduction by the employee under section 162. Revenue Ruling lists the following examples of benefits from which the employer derives a substantial business benefit that is distinct from the benefit it would derive from the mere payment of additional compensation: promoting a positive corporate image, maintaining employee morale, and avoiding wrongful termination suits. 3. FICA and FUTA Tax Exclusion for SUB Pay Section (a)-1(b)(4) of the Employment Tax Regulations specifically provides that, for purposes of ITW, any payments made by an employer to an employee on account of dismissal (i.e., involuntary separation from the service of the employer) constitute wages regardless of whether the employer is legally bound by contract, statute,

12 or otherwise to make such payments. Although there are no similar provisions in the regulations relating to FICA and FUTA taxes, the same conclusion generally applies. See H.R. Rep. No. 1300, 81st Cong., 1st. Sess. 124 (1949), C.B. 255, 277, & 300. See also Rev. Rul , C.B. 211, Rev. Rul , C.B. 340, and Rev. Rul , C.B. 15. The Service, however, created an administrative exception from employment taxes for supplemental unemployment benefits (SUB pay) certain payments made upon the involuntary separation of an employee from the service of the employer with the issuance of Rev. Rul , C.B The exception applies only if the payments are designed to supplement the receipt of state unemployment compensation and are actually tied to the receipt of state unemployment benefits, and in three limited situations where the employee is ineligible to receive state unemployment benefits; i.e., (1) where the employee does not have sufficient employment to be covered under the state system, (2) where the employee has exhausted the duration of state unemployment benefits, or (3) where the employee has not met the requisite waiting period. The plan at issue in Rev. Rul is specifically designed to supplement state system unemployment benefits payable to certain former employees. Employees must report to and register for employment with the state employment service. The plan also incorporates all of the state unemployment compensation law requirements designed to limit benefit payments to individuals who are unemployed and genuinely available for any suitable work. The plan benefits are payable only after an employee is unemployed for x weeks. The plan benefits are paid in varying amounts and for varying periods depending, in part, on the amount of state unemployment benefits available. Finally, in a state where SUB pay does not reduce state unemployment benefits, the unemployed individual cannot receive any other remuneration which would disqualify the individual from the state benefit, i.e., a plan payment is not SUB pay if the sum of that benefit and other remuneration from the employer disqualifies the recipient from receiving unemployment benefits in that state. In very limited situations, the plan benefits disqualify the recipient from state unemployment benefits, thereby entitling the individual to the payment of a substitute benefit. However, the plan is designed in such a manner that the benefits generally do not disqualify the recipient from state unemployment benefits. The ruling summarizes the following eight features of the plan: (1) benefits are paid only to unemployed former employees who are laid off by the employer; (2) eligibility for benefits depends upon meeting prescribed conditions after terminating employment with the employer; (3) benefits are paid by trustees of independent trusts; (4) the amount of weekly benefits payable is based upon state unemployment benefits, other compensation allowable under state laws, and the amount of straight-time weekly pay after withholding of all taxes and contributions; (5) the duration of the benefits is affected by the fund level and the employee's seniority; (6) the right to benefits does not accrue until a prescribed period after termination of employment; (7) the benefits are not attributable to the rendering of particular services by the recipient during the period of unemployment; and (8) no employee has any right, title, or interest in the fund until such employee is qualified and eligible to receive benefits. Revenue Ruling concludes that the plan benefits do not constitute wages for purposes of FICA tax, FUTA tax, or federal income tax withholding. Subsequent revenue rulings have broadened the scope of Rev. Rul , but only to the extent that the plans in question are similar in all material details or are substantially the same as the plan in Rev. Rul If the plans are substantially the same or similar in all material details to the plan described in Rev. Rul , then the absence of a single element may not be a material or controlling factor. The question is whether each plan's basic or fundamental purposes and conditions are the same as the purposes and conditions of the plan in Rev. Rul

13 In Rev. Rul , C.B. 46, the Service amplified Rev. Rul and concluded that a plan's failure to provide for the accumulation of funds in a trust account does not alter the conclusion of Rev. Rul In Rev. Rul , C.B. 212, the Service emphasized that a payment qualifies as SUB pay under Rev. Rul only if the payment is for a layoff that is involuntary on the part of the employee. In Rev. Rul , C.B. 211, the Service continued to recognize an administrative wage exclusion, albeit modified, for SUB pay. Rev. Rul holds that SUB pay is excluded from wages for FICA and FUTA tax purposes only if the receipt of SUB pay is actually linked to the receipt of state unemployment compensation (i.e., the plan payments satisfy the plan's design and purpose of supplementing the receipt of state unemployment compensation). Furthermore, it holds that lump-sum payments are not linked to state unemployment compensation since the amount of the benefit received is the same regardless of the length of the individual's unemployment. Therefore, to qualify as SUB pay for FICA and FUTA tax purposes, payments under a plan must be specifically designed to supplement state unemployment benefits and, under the terms of the plan, the employee must be unemployed and must meet the requirements necessary to receive state unemployment compensation benefits. Section 3402 of the Code, as added by section 805(g) of the Tax Reform Act of 1969, Pub. L. No , C.B. 10, extends ITW to any supplemental unemployment compensation benefit paid to an individual, regardless of whether it would otherwise be considered wages. Section 3402(o)(2)(A) defines supplemental unemployment compensation benefits as amounts paid to an employee pursuant to a plan to which the employer is a party, because of an employee's involuntary separation from employment (whether or not such separation is temporary) resulting directly from a reduction in force, the discontinuance of a plant or operation, or other similar conditions, but only to the extent such benefits are includible in the employee's gross income. ANALYSIS 1. Benefit payments under Option 1 are not subject to Employment Taxes Benefit payments under Option 1 are not subject to Employment Taxes. The premium payments under Option 1 were purchased by employees with after-tax dollars in their individual capacities pursuant to a plan in which the employer, Taxpayer, is not a party. These benefits therefore do not constitute wages. 2. Premum Payments under Option 2 are Working Condition Fringe Benefits. Premium payments made by Taxpayer on behalf of employees under Option 2 are not subject to employment taxes, and are not includable in employees' gross incomes, because they satisfy the definition of working condition fringe under section 132(d) of the Code, and the requirements set forth in (a)(2)(i) of the Income Tax Regulations. That is, if the employees had made the payments themselves such payments: (1) would be deductible by the employees under section 162 of the Code, and (2) would be deductible with respect to the employees' specific trade or business of being employees to Taxpayer. In particular, if Taxpayer's employees made the premium payments under Option 2 themselves, they would be entitled to deduct those payments under section 162 of the Code. That is, the premiums paid under the insurance contract are intended to insure wage continuation at a level based on an employee's existing salary for a stated benefit period during which the employee is unemployed. The premiums are analogous to the types of

14 contributions made to insure against business contingencies that Rev. Rul strongly infers are deductible. The insurance contract provides indemnity coverage for lost wages due to unemployment resulting from occupational or business hazards. It is a recognized aspect of employment that an employee may be terminated for business reasons. The insurance contract insures against this occupational risk and permits the taxpayer to carry on in the trade or business of being an employee. Since the insurance contract provides indemnity coverage for lost wages due to unemployment resulting from occupational or business hazards, an employee would be entitled to deduct the cost of premium payments for such an insurance contract as a business expense under section 162(a) of the Code. Furthermore, the employees would be entitled to deduct these premium payments as business expenses relating to their business of being employees of Taxpayer because Taxpayer derives a benefit from the Insurance Policy that is distinct from the benefit it would derive from the mere payment of additional compensation. As discussed earlier, examples of benefits that the Service has determined meet this requirement include benefits that serve to maintain employee morale, and those that minimize the risk that the employer will incur a wrongful termination suit. The Insurance Policy serves these goals. 3. Benefit Payments under Option 2 are SUB pay. The Plan is a SUB plan because it is similar in all material respects to the plan described in Rev. Rul , as modified by Rev. Rul ; i.e., the Plan is designed to supplement state unemployment benefits and the benefits are linked to the receipt of state unemployment compensation. Benefit payments that employees receive under Option 2 are therefore not subject to FICA or FUTA taxes. These benefit payments are, however, subject to ITW to the extent that they are includible in employees' gross incomes, under section 3402(o) of the Code. RULING Based on the information submitted and the representations made, we rule that: (1) Benefit payments under Option 1 are not subject to employment taxes, (2) Premium payments under Option 2 are neither includible in employees' gross incomes nor subject to employment taxes because they constitute working condition fringe benefits under section 132(d) of the Code, and (3) Benefit payments under Option 2 are not subject to FICA or FUTA taxes because the plan is a SUB plan. This private letter ruling is directed only to Taxpayer, who requested it. Code section 6110(k)(3) provides that it may not be used or cited as precedent. A copy of this letter ruling must be attached to any federal income tax return to which it is relevant. Sincerely, Lynne Camillo, Chief, Employment Tax Branch 2, Tax Exempt and Government Entities.

15 3. Federal Tax Day - Current, J.2, S Corporation Liable for Employment Taxes; Workers Were Employees, Not Contractors; Penalties Imposed (Atlantic Coast Masonry, Inc., TCM), (Aug. 14, 2012) 2012 Thomson Reuters/RIA. All rights reserved. Masons and laborers who performed services for an S corporation were employees, rather than independent contractors, and the S corporation was liable for employment taxes and penalties. The S corporation acted as a subcontractor providing masonry services using the services of numerous workers. Following the reclassification of the workers, the IRS determined deficiencies and imposed additions to tax for failure to timely file returns and failure to timely pay taxes, and penalties for failure to deposit employment taxes. The taxpayer used the services of a number of masons and laborers, each of whom was retained and paid on a perjob basis. The court reviewed factors relevant to determining employee status, including: (1) the degree of control exercised by the principal over the details of the work; (2) which party invests in the facilities used by the workers; (3) the opportunity of the worker for profit or loss; (4) whether the principal can discharge the worker; (5) whether the work is part of the principal s regular business; (6) the permanency of the relationship; and (7) the relationship the parties believe they were creating. Factors (1), (3), (4) and (5) weighed in favor of an employee classification, factor (6) weighed in favor of an independent contractor classification, and factors (2) and (7) carried no weight. The taxpayer sought relief under the Revenue Act of 1978, P.L , Sec. 530, which allows relief from reclassification of workers if: (1) the taxpayer did not treat the workers as employees; (2) the taxpayer consistently treated the workers as nonemployees on all tax returns; and (3) the taxpayer had a reasonable basis for not treating the workers as employees. Since the taxpayer did not file required information returns, including Forms 1099-MISC, with the IRS for any of the workers in question, the requirements for Sec. 530 relief were not met, and the taxpayer did not qualify for relief. The taxpayer was liable for all assessed additions to tax and penalties because it failed to show reasonable cause for: (1) failure to timely make the proper return filings under Code Sec. 6651(a)(1); (2) failure to timely pay the amounts of tax shown on the returns under Code Sec. 6651(a)(2); or (3) failure to timely make the required deposits under Code Sec. 6656(a). Atlantic Coast Masonry, Inc., TC Memo , Dec. 59,160(M) Other References: Code Sec CCH Reference FED 33, Code Sec CCH Reference FED 39, CCH Reference FED 39, Code Sec CCH Reference FED 39, Tax Research Consultant o CCH Reference TRC COMPEN: 3,102CCH Reference TRC COMPEN: 3,152CCH Reference TRC PENALTY: 3,050CCH Reference TRC PENALTY: 3,304

16 Tax Court Memoranda (Current), Atlantic Coast Masonry, Inc. v. Commissioner., U.S. Tax Court, CCH Dec. 59,160(M), T.C. Memo , T.C.M., (Aug. 13, 2012) Atlantic Coast Masonry, Inc. v. Commissioner. U.S. Tax Court, Dkt. No , TC Memo , 104 TCM 189, August 13, [Appealable, barring stipulation to the contrary, to CA-11. CCH.] [Code Sec. 3401] S corporations: Employment taxes: Employees: Independent contractors: Withholding of tax. Masons and laborers who performed services for an S corporation were employees, rather than independent contractors, and the S corporation was liable for employment taxes. The S corporation acted as a subcontractor providing masonry services using the services of a number of masons and laborers, each of whom was retained and paid on a per-job basis. The employer possessed the requisite degree of control over the masons and laborers to establish an employment relationship and, unlike their supervisors, they did not share in any profit or risk any loss. The taxpayer sought relief under the Revenue Act of 1978, P.L , Sec. 530, which allows relief under certain circumstances. However, as the taxpayer did not file required information returns, including Forms 1099-MISC, with the IRS for any of the workers, the requirements for Sec. 530 relief were not met. CCH. [Code Secs and 6656] Penalties, civil: Additions to tax: Failure to timely file returns: Failure to timely pay tax: Failure to timely deposit tax. An S corporation was penalized after its workers were reclassified as employees. The S corporation acted as a subcontractor providing masonry services using the services of one supervisor and numerous workers, who it considered to be independent contractors. The taxpayer was liable for all assessed additions to tax and penalties because it failed to show reasonable cause for (1) failure to timely make the proper return filings; (2) failure to timely pay the amounts of tax shown on the returns; or (3) failure to timely make the required deposits. CCH. James P. Dempsey (an officer), for petitioner; Jeremy H. Fetter and Shelley Turner Van Doran, for respondent. MEMORANDUM FINDINGS OF FACT AND OPINION JACOBS, Judge: Respondent determined that for purposes of Federal employment taxes, the individuals (corporate officers, masons, and laborers) listed in a table attached to a notice of determination of worker classification (notice of determination) should be legally classified as petitioner's employees and thus determined deficiencies in, additions to, and penalties with respect to petitioner's Federal employment and unemployment taxes as follows: Additions to tax Penalty

17 Period ended Type of tax 1 Amount Sec. 6651(a)(1) Sec. 6651(a)(2) Sec /31/04 FICA, ITW $36, $8, $9, $ /30/04 FICA, ITW 38, , , /30/04 FICA, ITW 46, , , , /31/04 FICA, ITW 30, , , /31/04 FUTA 9, , , /31/05 FICA, ITW 37, , , /30/05 FICA, ITW 18, , , /30/05 FICA, ITW 46, , , , /31/05 FICA, ITW 46, , , , /31/05 FUTA 16, , , , /31/06 FICA, ITW 48, , , /30/06 FICA, ITW 33, , /30/06 FICA, ITW 20, , /31/06 FICA, ITW 65, , , /31/06 FUTA 12, , , FICA refers to the Federal Insurance Contributions Act, secs ITW refers to the statutory income tax withholding required pursuant to sec. 3402(a). FUTA refers to the Federal Unemployment Tax Act, secs The amount of the sec. 6651(a)(2) addition to tax could not be computed at the time the notice was issued. In its posttrial brief petitioner concedes that for purposes of Federal employment taxes its two corporate officers should be legally classified as employees. Thus, the issues remaining for decision are: (1) whether the masons and laborers listed as workers on the notice of determination should be legally classified as employees as respondent maintains or as independent contractors as petitioner maintains; and (2) if the masons and laborers listed as workers on the notice of determination should be legally classified as employees, then (a) whether petitioner is entitled to relief from employment taxes pursuant to the Revenue Act of 1978, Pub. L. No , sec. 530, 92 Stat at 2885 ( section 530); (b) whether petitioner is liable for an addition to tax for failure to timely file returns pursuant to section 6651(a)(1) for the tax periods involved; (c) whether petitioner is liable for the addition to tax for failure to timely pay pursuant to section 6651(a)(2) for the tax periods involved; and (d) whether petitioner is liable for the penalty for failure to timely deposit tax pursuant to section 6656 for the tax periods involved. All Rule references are to the Tax Court Rules of Practice and Procedure, and unless otherwise indicated, all section references are to the Internal Revenue Code in effect at all relevant times.

18 FINDINGS OF FACT Some of the facts are stipulated and are so found. We incorporate by reference the stipulation of facts and the attached exhibits. Petitioner was incorporated in It elected to be treated as a subchapter S corporation for Federal income tax purposes. At the time petitioner filed its petition, its principal place of business was in Florida. During all relevant times petitioner acted as a subcontractor providing masonry services. Petitioner had gross revenues in excess of $1 million for each of the 2004, 2005, and 2006 calendar years. Petitioner had two shareholders/corporate officers, Blanche Dempsey and James Dempsey (Ms. Dempsey and Mr. Dempsey, or collectively Dempseys). The Dempseys each held a 50% interest in petitioner. Ms. Dempsey served as its president. She performed bookkeeping and clerical services for petitioner. She possessed signature authority on petitioner's checking accounts. Mr. Dempsey is a licensed mason and has worked in the masonry industry since He served as petitioner's vice president, procuring all masonry work it performed and overseeing its day-to-day operations. Mr. Dempsey submitted proposals for masonry jobs on behalf of petitioner to general contractors for construction projects. The proposals included in the record provide that petitioner would furnish all labor, materials, equipment, and supervision necessary to complete the job. Mr. Dempsey negotiated and executed the subcontract agreements (contracts) governing the work to be performed by petitioner. He issued invoices to the general contractors. The general contractors paid these invoices via checks made out to petitioner. The checks were then either deposited into petitioner's bank account or, more often, cashed at either petitioner's bank or at a local check cashing company. During the years involved all checks that were cashed on behalf of petitioner were cashed by either Mr. Dempsey or Ms. Dempsey. After commencing a project, Mr. Dempsey made purchasing decisions on behalf of petitioner with respect to the materials needed for the job, including the concrete and blocks to be used as well as a fastening gun and quantities of sand. If required, Mr. Dempsey rented cranes and forklifts on behalf of petitioner. The contracts with the general contractors provided that the materials so paid for belonged to the general contractor. Petitioner was reimbursed for the cost of the materials and lease expenses. Mr. Dempsey did not personally manage petitioner's construction projects. Rather, he contracted with others to supervise or be the foreman of the job. One such supervisor was William McNally. 1 Mr. McNally generally worked exclusively for petitioner, although in 2004 he worked for others as well. At the start of each job Mr. Dempsey would tell Mr. McNally: this is how much money that we have in this job, and do you think you can do it with your manpower? If the answer was yes, they would shake hands (there were no written contracts) and Mr. McNally would begin to organize the project. Mr. McNally's compensation, consisting of a base amount and a percentage of profits, was paid in cash. Mr. Dempsey testified that Mr. McNally and the other supervisors would make money based on their productivity, and we would split this job throughout the whole job. If the production was good, we made money, and if the production was bad we didn't. Mr. McNally received no fringe benefits from petitioner, and petitioner did not pay workers' compensation insurance premiums on his behalf. Because petitioner had no full-time workers other than the Dempseys, Mr. McNally's first responsibility was to find masons and laborers. These individuals were hired on a per-job basis. The record reveals that 30 masons and

19 laborers worked for petitioner in 2004, 66 worked for it in 2005, and 46 worked for it in Mr. McNally kept a telephone list of the masons and laborers with whom he had worked and would contact those individuals whenever he needed help. Often the masons and laborers Mr. McNally contacted would bring friends or relatives to the jobsite. Mr. McNally supervised the masons and laborers. He oversaw the number of bricks each mason laid per day and was responsible for the completion of the project on schedule. Mr. McNally had the authority to hire and fire masons and laborers at will. Mr. Dempsey could also fire anyone, including Mr. McNally, working on the project. Mr. Dempsey gave Mr. McNally the plans of the building project and instructed him that the building had to go up in a certain way, and I [Mr. McNally] made sure that was done on a daily basis. Mr. McNally liaised with the general contractor and was authorized by Mr. Dempsey to change, if necessary, specifications that had been agreed upon by petitioner and the general contractor. Mr. McNally brought in only experienced individuals. The masons and laborers brought their own tools with them, including trowels, levels, additional wheelbarrows, and tape measures. 2 At the commencement of the project Mr. Dempsey would visit the worksite to confirm that everything was in place, including the blocks, the cement, and the equipment. He would meet the masons and laborers and tell them what was to be done and how they would be paid and provide to them instructions relating to the masonry work. The masons and laborers worked an eight-hour day, but they were paid on a piecework basis. In other words, they were paid according to the number of blocks, bricks, or cubic yards of cement laid. Mr. Dempsey established the amount to be paid per block, brick, or cubic yard. The masons and laborers were paid weekly by Mr. Dempsey, who handed each of them envelopes with the appropriate amount of compensation in cash or delivered the envelopes to Mr. McNally for distribution to the workers. Petitioner maintained cash logs that recorded how much money each mason or laborer received as well as how much money Mr. McNally and the other supervisors earned. Petitioner stopped maintaining cash logs regarding masonry worker payments in the last quarter of 2006, which was approximately the time respondent began petitioner's tax examination. See infra p. 10. Although petitioner stopped recording cash outlays to the masons and laborers, its general ledger indicated that the amount of its gross receipts remained constant. Most of the masons and laborers worked exclusively for petitioner. When a particular job was completed, the masons and laborers were let go. If another job was in progress, Mr. McNally often invited them to join the new project if workers were needed. Petitioner's operations were conducted in a manner that, at best, could be described as informal. Transactions were conducted in cash and often not recorded adequately. Petitioner had few written contracts or agreements and the documentation that did exist was incomplete and contradictory. And it appears that regulatory filings were misleading, if made at all. Petitioner did not pay wages as such to the Dempseys. Instead, petitioner made multiple distributions to them and paid many of the Dempseys' personal expenses. These distributions and expenses totaled hundreds of thousands of

20 dollars over 2004, 2005, and Regional Forums Petitioner did not issue Forms 1099-MISC, Miscellaneous Income, or Forms W-2, Wage and Tax Statement, to the Dempseys for 2004, 2005, or Nor did petitioner file any information returns for those years. And the Dempseys did not timely file their Forms 1040, U.S. Individual Income Tax Return, for 2004, 2005, or Respondent has no record of petitioner's filing any Form 1120S, U.S. Income Tax Return for an S Corporation, during the years involved. Nor does respondent have any record of any Form 1096, Annual Summary and Transmittal of U.S. Information Returns, 3 or Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return, filed by petitioner for any of the years or periods involved. Petitioner filed one Form 941, Employer's Quarterly Federal Tax Return, for the fourth quarter of 2006, but respondent has no record of any others. Respondent prepared substitutes for returns with respect to all of petitioner's unfiled information returns. On September 26, 2006, respondent notified petitioner that it had been selected for employment tax examination. Two weeks later (i.e., October 14, 2006), the Dempseys filed their respective Forms 1040 for On January 19, 2007, they filed their respective Forms 1040 for On January 4, 2007, approximately three months after respondent commenced his examination, petitioner submitted to the examining agent Form 1120S for petitioner's 2004 tax year, 4 as well as copies of a 2004 Form 1096, a Form 941 for the fourth quarter of 2006, and a Form UCT-6, Florida Department of Revenue Employer's Quarterly Report. Petitioner also provided Forms 1099-MISC for the years involved for some of the masons and laborers. For 2004 petitioner provided Forms 1099-MISC for 11 of the 30 masons and laborers whom petitioner paid $600 or more during that year; for 2005, petitioner provided Forms 1099-MISC for 9 of the 66 masons and laborers whom petitioner paid $600 or more; and for 2006, petitioner provided Forms 1099-MISC for 18 of the 46 masons and laborers whom it paid $600 or more. At trial Mr. Dempsey admitted that the information returns filed were prepared after they were due. Respondent determined that the Dempseys failed to report the following amounts of wages from petitioner: Employee Ms. Dempsey $86, $47, $74, Mr. Dempsey 96, , , Petitioner maintained a workers' compensation insurance policy which did not cover any of the masons or laborers. Petitioner never inquired as to whether any of the masons or laborers had their own insurance. It appears they did not. Petitioner's workers' compensation insurance carrier conducted a policy audit of petitioner for the period of April 1, 2004 through The audit report named Ms. Dempsey as an employee of petitioner, Mr. Dempsey as a subcontractor, and two unrelated businesses, Forte Crane and John A. Walker & Sons, as subcontractors. It did not mention Mr. McNally, the masons, or the laborers. OPINION I. The Workers' Legal Classification