California business owners take heed: the Internal Revenue Service published the “Executive Compensation – Fringe Benefits Audit Techniques Guide” giving you a road-map to what it will examine when auditing your executive perks.
Corporate executives in Los Angeles County, Santa Barbara County, Ventura County and Orange County and throughout California often receive extraordinary fringe benefits that are not provided to other employees. New income tax problems arose because of changes in the law.
In 1984, the Internal Revenue Code (“Code”) was changed to include the term “fringe benefits” in the definition of gross income found in Code §61. A fringe benefit provided in connection with the performance of services, regardless of its form, is treated as compensation includible in income under Code §61. Any property or service that an executive receives in lieu of or in addition to regular taxable wages is a fringe benefit that may be subject to taxation.
Whether a fringe benefit is taxable depends on whether there is an exclusion under the law that applies to the benefit. For example, when Code §61 was amended to include the term “fringe benefits”, §132 was added to provide exclusions for certain commonly provided fringe benefits.
Section 132 provides exclusions for working condition fringes, qualified moving expenses, de minimis fringes, no additional cost services, qualified transportation fringes, qualified employee discounts and qualified retirement planning services.
Although 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 and thereby not 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 several potential issues regarding fringe benefits. There are both income and employment tax issues related to fringe benefits.
Is the amount excludable from gross income of the executive?
Is the expense deductible by the corporation?
Is the executive receiving personal benefit from the corporation?
Does the benefit exceed the certain limitations described in the Code (for example, see §162(m))?
The following discusses some of the most common fringes provided to executives that may receive the scrutiny of the IRS:
Athletic Skyboxes/Cultural Entertainment Suites Awards/Bonuses Club Memberships Corporate Credit Card Executive Dining Room Loans Outplacement Services Qualified Employee Discounts Security-related Transportation Spousal/Dependent Life Insurance Transportation Chauffeurs Employer-paid parking Transfer of Property Employee Use of Listed Property Relocation Expenses Non-commercial Air Travel Employer-paid vacations Spousal or Dependent Travel Wealth Management Qualified Retirement Planning
If the IRS is challenging you on any of these issues, please call Mitchell A. Port at (310) 559-5259 to discuss your options.