There may be errors in spelling, grammar, and accuracy in this machine-generated transcript.
Jeremy Wells: Employers often provide free or reduced price goods or services to their employees as a job perk. Uh, the employee market has been, uh, kind of a roller coaster the last few years here. We've gone through periods where employees were incredibly difficult [00:00:30] to find. We've gone through periods where there was relatively high unemployment, and that can also vary across different industries and professions. And so employers are constantly trying to figure out ways to encourage either prospective employees to want to come work for them, or for current employees to want to stay. And benefits as a job perk is one of those. So for the next couple of episodes, I'm going to be breaking down what tax [00:01:00] law says about the kinds of benefits we can and can't offer employees, and how those benefits are treated for tax purposes. So although a lot of companies and workers, uh, prefer to see these perks as just harmlessly nontaxable tax law actually tells us the opposite. Irc 61 A1 includes in compensation [00:01:30] for services, commissions, fringe benefits, and similar items in gross income. So in other words, if you get some sort of fringe benefit from your employer, it's taxable unless later on in the code, there is some specific exception that allows you to fully or partially exempt that amount from your income. So [00:02:00] in this episode, I'm going to look specifically at two common kinds of fringe benefits no additional cost services, and then also qualified employee discounts.
Jeremy Wells: These are a couple of the most common fringe benefits that we see. Now there are other benefits that are not fringe benefits. These are typically health insurance plans and retirement plans that you get through your employer. And I'll have episodes on those in [00:02:30] the future. Each of those individually are pretty big, complex topics. I could probably do a multi-episode series on each one of those. And here fringe benefits. There's a particular code, section 132, that lists some specific fringe benefits that are specifically excluded from income if the employer and the employee follows the rules. So for the next couple of episodes, I'm going to talk about those fringe benefits. This episode. We're going to [00:03:00] focus on no additional cost services and qualified employee discounts. So we're going to look at the statutory and regulatory criteria for excluding those two types of benefits, those no additional cost services and qualified employee discounts. Under section 132, we're going to look at one phrase in particular out of these two benefits called the line of business limitation. And we're going to look specifically at what that means. [00:03:30] What does it mean to be in a line of business? What does it mean for an employee to provide services to an employer within a line of business? And what effect does that have on fringe benefits? We're also going to look at what the definition of an employee is when we're looking at eligibility for these fringe benefits, and it means something a little bit broader than an individual worker who is on your payroll today is actually more people than that that could qualify as an [00:04:00] employee.
Jeremy Wells: We're also going to look at nondiscrimination requirements and what that means for certain key individuals within a business, and how they may or may not qualify for these fringe benefits. In particular, we're going to look at highly compensated employees. And then finally, we're going to look at how we can advise employers as our clients. If you're a tax professional or, uh, how you yourself within your business, [00:04:30] if you're a business owner, uh, can look at whether your business and your employees qualify for these benefits and how you would go about actually providing these benefits and documenting them so that you're compliant with section 132. Let's start off with no additional cost services. Now an employer can exclude the value of no additional cost services provided to its employees. In [00:05:00] general, there are some restrictions and limitations here that we'll talk about, but in general, this is the first fringe benefit listed in IRC one. 32 is no additional cost services. A no additional cost service is one provided to an employee for personal use. So the employee is getting the benefit of this service. It's ordinarily offered for sale to customers, and [00:05:30] it incurs no substantial additional cost or foregone revenue when provided to the employee. Now, each of these terms, each of these phrases that I've, that I've put some emphasis on, as I've explained, this is going to have some qualifications and some limitations to it.
Jeremy Wells: And I'll discuss this, uh, here in a few minutes. But in general, a no additional cost. Service is where the employer provides a service to the employee [00:06:00] that is a service that's ordinarily offered to that employer's customers, and it doesn't incur any additional cost. And the employer isn't giving up any revenue in order to provide that service to that employee. That's IRC section 132 B, and it's also coming out of Treasury Regulation 1.1322, in particular to a. But this Treasury Regulation 1.1322 discusses [00:06:30] no additional cost services. Uh, in fact, as we go through each of these fringe benefits, uh, each of them has its own section in the regulations. Now, an employer is responsible for determining whether the provision of a no additional cost service, as the name implies, actually costs anything, and the phrase that is used in the code is a substantial [00:07:00] additional cost. So the employer determines the cost of providing that no additional cost service, irrespective of any amount paid by the employee or reimbursement offered to the employee for the service. So let's start here. Let's think about a service that an employer might provide to one of its employees, or to any of its employees. It's the employer's job to determine [00:07:30] the cost of that service, and it has to do that without taking into account whether it's going to actually charge the employee any money to provide that service, or if it's going to offer to reimburse the employee for that service.
Jeremy Wells: If the if the employee is going to pay full price, and then the employer is going to turn around and reimburse part of that. So it can't factor the net profit from providing that service to an employee into [00:08:00] account. It has to just strictly look at the cost, and we'll talk more in a minute about how those costs are determined. The employer has to include the cost of labor incurred in providing the service, to determine whether the employer has incurred substantial additional cost. There's going to be a theme here, as we're talking about some of these fringe benefits that these regulations and the code section itself were [00:08:30] written with a particular sort of tone to them that really comes out of the industrial age. There is a an emphasis here on the way a traditional manufacturing economy would operate and think about providing products and services to employees. What we have to do now in 2025 is think about how to interpret [00:09:00] some of these provisions in a service based economy. We still have a lot of manufacturing work going on in the US, but we have much more. We have a much stronger service based economy than we did when a lot of these rules were written.
Jeremy Wells: One of the key differences between service based businesses and manufacturing businesses is this concept of cost of goods sold. And [00:09:30] within that concept is the direct cost of labor in providing a service or a product. This is going to come up, especially when we start talking about employee discounts in the rules for no additional cost services. A key part of the calculation here is the actual cost of labor incurred in providing that service. Depending on the business model of the employer, [00:10:00] it might be difficult to actually determine the particular cost of labor of providing a specific service. However, it's incumbent on the employer to provide that. To calculate that, in order to determine whether the employer has incurred substantial additional cost or not. In a prior episode, I talked about the importance of record keeping and part of record keeping. It goes beyond [00:10:30] bookkeeping and accounting, but part of that bookkeeping and accounting is being able to track the cost of whether goods or services that the employer that the business is providing with the goal of calculating what the actual whether we're talking about cost of goods sold in a manufacturing context, or maybe the cost of services in a more advanced service [00:11:00] based business, a more modern service based business. Either way, we have to come up with some way of determining what the cost of labor of providing this service is and using that to decide whether or not there's actual substantial additional cost in providing the service to the employee.
Jeremy Wells: The employer incurs substantial additional cost if the employer or its employees spend a substantial amount of time providing the service [00:11:30] to employees. We don't really get more detail than that. This is all coming out of Treasury Regulation section 1.1 32 to A51. You've got to go pretty deep into this regulation to find this. And we still don't have any details on what we mean by a substantial amount of time providing the service to employees. In other words, it's going to be subjective here. We're going to have to decide whether or not the employer has spent a substantial [00:12:00] amount of time, uh, or the employer's employees, uh, have spent a substantial amount of time providing the service to employees. The idea here is we don't want to be calling, uh, a no additional cost service to an employee, a benefit when really, that's all that business does. Um, or at least most of what it does. We want the business focusing on customers providing goods or services to customers. And then if along [00:12:30] that way, the business is able to, at no substantial additional cost, provide that same service to one of its employees or a few of its employees, that's fine. What we don't want is the business to be focused solely on providing these services to its employees or spending a substantial amount of time doing that.
Jeremy Wells: Now, incidental services generally don't incur substantial additional cost. What do we mean by this? If this is [00:13:00] something that the employer that the business would have to do, uh, that is secondary. That's incidental to its normal operations, to the normal service that it provides, then that generally doesn't incur substantial additional cost. So if this is not the main service, but it's an ancillary service, it's a contributing service. It's something that's incidental to what it normally does. Then in [00:13:30] that case then we're not going to worry. We almost have a safe harbor here against worrying about substantial additional cost and therefore being able to say that this could qualify as a no additional cost service to an employee. Employers can't exclude reserved services, and this is key to understanding the distinction between a no additional cost service that qualifies and one that does not. What [00:14:00] we're talking about here is one way to think about it is excess capacity. If the employer if the business has excess capacity to provide a service that it normally offers to customers and for no additional cost, and without the potential of forgoing any revenue, it can also provide [00:14:30] that service to its employees. Then we're probably looking at a no additional cost service. What can get a company in trouble is if that company then Begins allowing employees to reserve their place in line to get that service, or to put themselves in competition with prospective customers over when and how they're going to get that [00:15:00] service.
Jeremy Wells: So, for example, here, the regulations provide an example of a commercial airline allowing employees to reserve seats on flights at no charge. Now, an airline can absolutely provide flights in unreserved seats as excess capacity. This is normal. This has been standard practice for commercial airlines for a long time. You have a flight between two cities [00:15:30] and one of the airline's employees is in the departing city, but they live in the arrival city. And so that employee just wants to take a ride on that plane to get back home. But the plane is sold out. There's no room for that employee on that plane. That employee can't just jump right on that airplane. There's nowhere for that employee to sit. Now, if that [00:16:00] flight had some empty seats, and at the time that the flight was about ready to close the door and take off from the airport, there were still some empty seats. That employee could then take one of those seats. That's excess capacity. Nobody is trying to buy a ticket for that seat. Then that employee can take that seat. That's fine. And the value of that flight for the airline? The airline wasn't going [00:16:30] to sell that ticket anyway. So the airline isn't losing anything. It's not paying any more than it had to to add one more passenger to that flight. It's also not giving up any potential revenue because that seat can't be sold once the flight is already taking off.
Jeremy Wells: So that employee can take that seat. However, what the employee can't do is reserve one of those seats when customers can still book seats on that flight. At that point, that airline [00:17:00] is going to potentially lose revenue if a customer wants to book that flight but can't because the employee took the last seat. So in these cases, you are not allowed to consider that a no additional cost service and therefore a nontaxable fringe benefit to that employee. That employee can take that seat if it's empty, when the plane is ready to take off, the employee can't reserve that seat [00:17:30] and still get it as a nontaxable fringe benefit. Now the employee could do that and not pay the airline. The airline would then need to add the value of that ticket to the employees compensation as taxable income as part of the employees wages. This is from Treasury Regulation 1.1322. See? What's interesting about no additional cost services is that employers can reciprocally offer those services to the employees [00:18:00] of other businesses. So, for example, say you have two businesses that are unrelated to each other, and they're they they provide different kinds of services. Those two businesses could make an agreement with each other to provide their services to the employees of the other business. And that would count. Or it could count as a nontaxable fringe benefit for those employees. [00:18:30]
Jeremy Wells: In order to do this. An employer has to have an agreement with an unrelated other employer, And that agreement needs to satisfy these conditions. It has to be a written reciprocal agreement. So company A will provide a certain service to company B, and company B will in turn provide a certain service to company A. The employee that's going to take advantage of this reciprocal [00:19:00] agreement could exclude the value of that no additional cost service. If she could exclude the value of the service if her employer provided it. An employee of company A is going to get that service from company B, but she could have gotten it from company A if company A actually offered that service. It just doesn't. So by way of this reciprocal agreement, she can get it through company B instead. Now neither [00:19:30] employer can incur any substantial additional cost. That's the third condition here. So the first one is that it's a written reciprocal agreement. The second is that the employee could exclude the value of that service if her own company were providing it. And then third, neither employee employer incurs any substantial additional cost, including potentially forgone revenue, by providing the [00:20:00] service to the employees of the other employer. If there are any payments involved between the two companies, then that is by definition a substantial additional cost and the entire agreement breaks down. So it's not that company A can agree to provide the service for company B, as long as company B provides the service for A and also attaches [00:20:30] some sort of payment to that.
Jeremy Wells: It just has to be a straight up trading services for services agreement. In that case, it qualifies. If there's any exchange of money involved, then that blows the deal. Who can get these benefits? What kinds of employees within the business can get these benefits? And here's where we start seeing some limitations. So in particular we're worried about [00:21:00] highly compensated employees. Now highly compensated employees can exclude no additional cost services, but only if the employer offers that service on substantially the same terms to each member of a group of employees. Under a reasonable classification system that does not discriminate in favor of highly compensated employees. In other words, the employer can't [00:21:30] make arbitrary decisions about who gets to take advantage of this business. There has to be a reasonable basis for classifying groups of employees that have access to this benefit or not. And usually that looks something like a an employee meeting a certain threshold in terms of, uh, probationary period. So once an a new employee has worked for the business for at least six months or one year, [00:22:00] then that employee is now eligible for the fringe benefit. That is an example of a pretty common and reasonable classification system for employees, where employees that haven't finished their probationary period aren't allowed to take advantage of fringe benefits.
Jeremy Wells: But once they have gotten out of that probationary period, then they have the same access as any other employee. A highly compensated employee, by definition, is [00:22:30] any employee who was a 5% owner at any time during the year or the preceding year, or for the preceding year, had compensation from the employer in excess of the threshold under IRC section 414. Q, now 414 Q is part of the code that's dealing with retirement plans. And there's discussion in that [00:23:00] part of the code of what employees qualify for under retirement plans. And what we'll see in section 132 on fringe benefits is a lot of references back to that particular subsection of the code that explains what a highly compensated employee is. There's also a regulation under section 132, which Treasury Regulation 1.1328 [00:23:30] that discusses Nondiscrimination rules for fringe benefits, so it's helpful to read both of those in context of thinking about which employees can qualify, uh, for these fringe benefits. The highly compensated employee threshold for 2025 is $160,000 of compensation. So if an employee makes less than $160,000 in compensation, [00:24:00] uh, then that employee is by definition, not a highly compensated employee, as long as that individual is not a 5% or greater owner in the business, if that individual owns 5% or more of the business, or has compensation in excess of $160,000 in 2025, then that individual is by definition a highly compensated employee.
Jeremy Wells: Now that individual is still eligible for no [00:24:30] additional cost services as long as the rules are written such that other employees are also eligible. At least another class, a reasonable class of employees, is also eligible. Let's look at employee discounts now. So that's that's no additional cost services. That's where the employer is actually providing the service to the employee. Employee discounts are a little bit different. Employee discounts are for both services [00:25:00] or products. And in fact under the no additional Cost Services subsection of section 132, uh, you find that for services where an employee may not qualify or an employer may not qualify to provide a no additional cost service, then an option might be to provide that service with a qualifying employee discount. And a qualifying employee discount is available for both Services [00:25:30] and products if the employer and the employee qualify. So an employer can exclude the value of a qualified employee discount provided to its employees if the discount meets certain criteria. The first one is that a discount on a service can't exceed 20% of the price offered by the employer [00:26:00] to customers. So straight up, you can give your employees up to a 20% discount on services compared to the price that a normal customer would have to pay. So if your business provides a particular service to its customers for $100, then you can offer that same service to your employees for no less than $80 [00:26:30] and not consider any of that $20 discount.
Jeremy Wells: Part of that employees gross income. That's for services for property. Then the discount can't exceed the gross profit percentage on the price offered by the employer to customers. Now we'll talk about what gross profit percentage [00:27:00] and the price offered by the employer to customers means here in a minute, because of course, there's a lot that can go into that. There's a lot of ways that both of those terms could be interpreted and calculated. Now, an employer includes the value of any excess discount in the employee's taxable compensation. So go back to that discount on service 20%. The discount on that $100 [00:27:30] service can't exceed 20% of that or $20. So what happens if the employer doesn't fully understand that 20%, or wants to offer a discount in excess of 20%, and instead says 30% discount? In that case, the excess discount or that additional 10% or $10 off of that $100 service that is considered part of the employee's taxable compensation. So if you're thinking about that employees pay stub, you [00:28:00] might actually see that there is a tax free benefit offered of a qualified employee discount of $20. That's the acceptable discount on that $100 service. And then you might see another line that is the taxable portion of that employee discount of $10. And that $10 would be added to the employee's gross compensation. [00:28:30] This part here on employee discounts.
Jeremy Wells: This is all coming from IRC section 132. So 132 B is all about no additional cost services. 132 C is all about qualified employee discounts. Also, Treasury regulation 1.1 32 three talks about employee discounts. When we're looking at the price for a product, [00:29:00] in order to determine the maximum employee discount that A that an employer could offer, then we're looking at aggregating prices and costs. In order to calculate gross profit, an employer calculates the gross profit percentage using the aggregate sales price of property sold to customers, and the aggregate cost of that property. This includes all property [00:29:30] ordinarily sold by the business, or a reasonable class of property chosen by the employer over a representative period. That's IRC section 132 C2. So let's think about this. Let's say we've got a small retailer that sells, uh, lawn care equipment, mowers and shovels and rakes. You know, that that kind of stuff. So let's [00:30:00] say we've got, uh, lawn mowers, push lawn mowers. And this business is going to offer its employees a discount on buying a push lawn mower from the from the business itself. So how would that business go about calculating the maximum discount that it could give to its employees? Uh, and, and that discount would be tax free in that case. What this [00:30:30] paragraph is telling us is that the employer is first going to look at the aggregate sales price, either of all property sold to customers.
Jeremy Wells: So everything that that business sells could look at all of that or a reasonable class of property chosen by the employer. I think in this case, a way to interpret that might be because we're talking about push lawn mowers. Let's just restrict this to a reasonable class of property. Would be [00:31:00] just looking at push lawn mowers. Right. So let's just look at those. And let's look at the aggregate sales price. So of all of our push lawn mowers what is the aggregate sales price of all of them. In other words what's the average what's the average push lawn mower that we sell. Some of them are going to be cheap. Some of them are going to be expensive. Some of them are going to be top of the line, right? Let's just get an average price. Um, and aggregate that. On the [00:31:30] flip side, the ones that are really nice are going to cost the store more to purchase and put into inventory than the more, uh, than the cheaper ones. Right. And so in order to think about the cost of that property, again, the business is going to look at the aggregate. So how much does the does the average push lawn mower cost the business, and how much does it then turn around and sell. The average push lawn mower for that is going to give us [00:32:00] the gross profit percentage, right. And then we need to look at that over a representative period.
Jeremy Wells: Usually this is a year a tax year a calendar year. Uh, it could be a representative period. Uh, on the other hand, there might be some qualifications here if we're talking about offering this particularly, uh, during a peak time, such as around the holidays, or if we're selling lawn care equipment, maybe in the spring, then we would [00:32:30] want to account for that because our pricing might change, we might have sales, we might increase prices due to extra demand. So the prices could fluctuate throughout time. And so we want to make sure we're doing that over a representative period. Usually the best way to take into account a lot of that sort of variation is to just look across a calendar year or fiscal year. Either way, it's up to the employer to do this and make sure that it is [00:33:00] reasonable. This is section 132 C2 uh, or in the Treasury regulation 1.1 30 23C if the employer provides regular group discounts, then the employer can take that into account in Calculating the aggregate price of the good that it's selling. So if an employer regularly sells goods or services at discounted [00:33:30] prices to certain customer groups, and those discounted sales make up at least 35% of its total sales for a typical year, then that discounted price counts as the customer price when figuring an employee discount. So think about what we're trying to do here.
Jeremy Wells: We're trying to reduce the customer price in order to increase the gross profit [00:34:00] percentage, which is going to increase that maximum employee discount, right? So if an employer regularly sells goods or services at discounted prices to certain customer groups, and that makes up at least 35% of the total sales for a typical year, then that discounted price is really for purposes of calculating the maximum [00:34:30] employee discount. It's really the the customer price. If we have to take into account the fact that we really normally charge a lower price than that, gross profit is going to be less. Um, I might have said more a minute ago. It's actually less right that gross profit is going to be less, and therefore the percentage, uh, is is going to be, uh, less. And so that, uh, that discount is going to be less as well. [00:35:00] We can't discount more if we're selling on average this product for less. In other words, we're trying to avoid inflating the price in order to act like we can afford a bigger discount for our employees. So if the employer regularly provides discounts to multiple groups, then it gets to choose the most common discount the one producing the largest share of total discounted sales as the benchmark. [00:35:30] Or if there's a tie, it can average between them, right? So in other words, think about your business that might have particular groups that it regularly offers discounts to seniors, military, uh new home buyers.
Jeremy Wells: Right. There could be lots of these different groups that will get a regular discount buying from this particular company. If the [00:36:00] sales make up at least 35%, then that becomes the customer price that, uh, normally discounted price, not the normal price before that group discount is applied. This is from Treasury Regulation 1.1 32 3B2. Four. Again, some of these uh points, they get a little deep in the regulation, but they're important. [00:36:30] And if we're working with an employer, with a company, a client that regularly does these discounts and these discounts are practically everywhere. Now, um, you know, you can shop at a lot of different businesses that will offer discounts for different, uh, particular groups. Now, whether those discounts then accumulate to make up at least 35% of the sales of that business, you [00:37:00] know that that's probably not as likely. However, depending on the industry or the profession that you're working with or the particular niche or market that that business attracts, that discount might actually be more popular for that particular business, and if so, really need to take that into account when thinking about how to calculate these qualified employee discounts. Again, as we [00:37:30] had with the no additional cost services, there's a requirement here that the employer has to ordinarily sell the discounted good or service to its customers. This discount is available for any product or service that the employer ordinarily offers for sale to customers, except real property.
Jeremy Wells: So no real estate, no discounts on real estate, buildings, land, that sort of thing, or personal [00:38:00] property usually held for investment, such as securities, commodities or currencies. So even if the employer, let's say it is a brokerage that regularly deals in securities or commodities or it's a currency exchange. Even in those cases, if that's the normal product available for sale through that employer that is not eligible for a qualified employee [00:38:30] discount. And then, other than those exceptions, the business needs to ordinarily sell the good or service, and the employee has to normally provide services to that employer related to that good or service. Now I'll talk more about the line of business, uh, requirement here in a minute. But it's [00:39:00] important to keep in mind that it's not enough just to say, well, the employer normally sells this to customers. The employee also needs to be involved in the department or the part of the business that normally sells that good or service. This is written in response to a lot of the conglomerates, especially the international conglomerates, that started forming in [00:39:30] the later 20th century and then moving especially into the 21st century. You started seeing businesses merging and acquiring other businesses, and pretty soon a business didn't offer just one type of good it might offer ten, 20, you know, 50 different kinds of services or goods all within the same conglomerate.
Jeremy Wells: And in that case, it would be difficult to say that an employee in one sector of that business was [00:40:00] really providing services and therefore should be eligible for a discount on some sort of good or service that was sold in a whole different part of that major corporation. So, uh, the line of business requirement was added. And then this part of the regulation was. And the and the code section was written in such a way to make sure that employees were getting no additional cost services, but then also discounts on goods or services that they were actually related to within [00:40:30] that business. Unlike no additional cost services, there is no reciprocal agreement available for qualified employee discounts. That's Treasury regulation 1.1 323A3. You can't create a reciprocal arrangement with another company to provide discounts on goods or services. That's going to provide some sort of tax free benefit to your employees. That's not allowed [00:41:00] for discounts. It is allowed for no additional cost services. It's not allowed for discounts. Now, employers can also provide discounts to highly compensated employees. Again, with the same nondiscrimination requirements as we saw, with no additional cost services. So to offer those discounts, the employer has to offer the discount on substantially the same terms to each employee in a reasonably classified group of employees [00:41:30] that doesn't discriminate in favor of highly compensated employees, and again, see the same uh, citations to IRC section 414 Q for the definition of a highly compensated employee, and then also to Treasury Regulation 1.1328 for fringe benefit nondiscrimination rules.
Jeremy Wells: Now, lines of business. I've already mentioned this a little bit, but what is a line of business and where does this factor [00:42:00] in. So an employee has to perform services in the ordinary course of the same line of business in which the employer offers property or services for sale to customers to qualify for a tax free, no additional cost service or a qualified employee discount. In this case, we actually go to Treasury Regulation 1.1324 in order to, uh, hear about these, uh, same line of business requirements. [00:42:30] So there's an entire section of the section 132 regulations that focuses on this idea of the same line of business in order to qualify for either the no additional cost service or the qualified employee discount, the employee has to be in the same line of business as the good or service that's included with this fringe benefit. Now, selling a product or service primarily to employees rather than customers [00:43:00] automatically is a deal breaker. It does not satisfy the line of business limitation because if the business is only selling this product or service to its employees. Then it's not in that line of business when it comes to selling to its customers. As an example, consider a bank, right? Uh, a bank can't provide discounted, uh, apparel or groceries to its employees if it doesn't also [00:43:30] primarily sell clothing and groceries to its customers.
Jeremy Wells: And obviously, a bank usually doesn't do that. So those would not be appropriate fringe benefits. Those would not be qualifying, uh, discounted benefits or no additional cost services for its employees. An employee can work in multiple lines of business, though, and so if an employee works in more than one line of business, [00:44:00] then that employee qualifies for no additional cost services and employee discounts in any of those lines of businesses in which that employee provides services to the employer and an employee could provide services that indirectly benefit multiple lines of business. So it's entirely possible, for example, that, uh, you've got employees that are on [00:44:30] the administrative side, maybe, uh, custodians, engineers. Right. All of the kinds of infrastructure workers that literally keep the lights on. So they're not the ones actually dealing with customers or making the products or providing the services, but they are working for the business, and their work is a benefit to at least one, if not multiple lines of business within that company. In these cases, [00:45:00] then that employee qualifies for the discount or the no additional cost services in any of those lines of business that indirectly benefit from that employee services. It's interesting looking at where we can actually go to determine which line of business a company is in. If you prepare business tax returns, even schedule C's, but also partnership [00:45:30] or S corporation returns, you know that those returns have a line on which we include a code that indicates which kind of industry or profession that business is in.
Jeremy Wells: Originally, that code system, that classification system for businesses was called the standard Industrial classification. And it the a particular version of this [00:46:00] is the enterprise standard Industrial Classification or the SEC. And there's a manual for this that the Office of Management and Budget, part of the US federal government, created in order to help various departments within the federal government organize the way it collected data about business. So you have the Census Bureau, you have the Commerce Department, you have the different budgetary parts of the government, and they're [00:46:30] all trying to coordinate on how they're classifying businesses in order to determine things like whether certain industries or professions are growing or not, how they should do in terms of paying taxes, in terms of employment figures, all these kinds of things. So the federal government decided there needed to be a standardized way of classifying all these businesses. That's what the manual provided. However, that manual was developed in 1938 [00:47:00] and has not been updated since 1974. So earlier in this episode, I said a lot of the way of this thinking about fringe benefits is based on an outdated way of thinking about a primarily manufacturing based economy. Well, the US economy between 1938 and 1974 was based on manufacturing. Since 1974, the US economy has changed.
Jeremy Wells: Now, for those of you that prepare those [00:47:30] returns, you know that it is a six digit code by the North American Industry Classification System, the NAICs or the Naic system. That was a collaboration among the US, Mexican and Canadian governments that created that system in 1997, and it's been most recently updated in 2022. So it's a little bit more up to date. It's a little bit more modern than the old standard industrial classification [00:48:00] system. And so Yeah. Just this year, in August of 2025, the Treasury Department proposed regulations that would update, uh, the uh section 132 regulations to reference the NAICs system instead of the SEC system. So currently the regulations, the 132 regulations say that a line of business is determined by the first two digits in the sick [00:48:30] or the standard industrial classification system. But again, those codes haven't been updated since 1974. There are a lot of industries and professions that exist now that didn't exist 50 years ago when that manual was last updated. Naics includes a lot of that, but it's going to take the Treasury Department going through its normal, uh, regulation revision process in order to get that updated [00:49:00] in the regulations Employers can offer goods or services to employees only, as no additional cost services, or for an employee discount only if they also provide that product or service to customers for sale. Uh, even if the product or service is within the employer's line of business, it still has to be available for [00:49:30] sale to customers in order to qualify.
Jeremy Wells: The meaning of an employee for purposes of the qualifying employee discount, or for no additional cost services, is actually broader than someone currently working for the business. Uh, so the following are considered employees for purposes of these two fringe benefits. This is Treasury regulation section 1.1 32 1B1A current employee in the employer's line of business, which is what we'd [00:50:00] normally think of when we think about employees, but also a former employee in the employer's line of business who separated due to retirement or disability. Also a widow or widower of a former employee in the line of business who died while employed or separated due to retirement or disability. A partner who performs services and this is important. A lot of times with these benefits, we have differing rules as to whether [00:50:30] partners qualify for those benefits or not. In this case, a partner in a partnership who performs services for the business qualifies for these fringe benefits. And then finally, a spouse or dependent of an employee. Um, also, so that spouse or dependent has to be reported on that worker's tax return. There's an interesting, uh, tax court case, Michalek v Commissioner. Uh, this is Tax Court Memorandum 20 2236. Where [00:51:00] the petitioner is worked for a commercial airline and took his family on flight and under the regulations, his spouse and his dependent children qualified for no additional cost services, meaning they could fly on those flights for free as long as those seats were available and they took advantage of that.
Jeremy Wells: However, there were a couple of family members [00:51:30] who were no longer dependent, and the airline correctly identified them and reported the value of their flight on a form 1099. Miscellaneous. To Michalek, who then subsequently just ignored the 1099 miscellaneous, thinking that he should not have to include that amount in income, did not report it on his tax return in any way. Of course, the IRS question. This, uh, [00:52:00] assessed the tax along with penalties and interest and tax court found in the IRS's favor because those individuals were not dependents, qualifying under the code section regulations for these fringe benefits. Now, interesting. It's it's irrelevant for this particular case, but the court mentioned in a footnote and pointed out that IRC section 130 2H3 does [00:52:30] add parents of an employee to the list of individuals who qualify for no additional cost services, uh, but only for airline travel, not for any other industries or professions. So to sum up, we want to make sure that if we are working with clients or if your business is interested in offering no additional cost services or qualified employee discount that you pay attention to what the rules [00:53:00] are, determine the line of business, and make sure that the employee performs services within that line of business.
Jeremy Wells: Document the employees regular work to show that, uh, confirm that the service or the property is offered for sale in the ordinary course to customers, not just to employees, for no additional cost services. Quantify whether the employer incurs any substantial additional cost or forgone revenue, and make sure to document [00:53:30] that that it's not actually costing the business anything, especially in terms of potentially foregone revenue, that one can be difficult to prove. For employee discounts, make sure that you properly calculate the gross profit percentage and the 20% cap for services. Document the terms of the benefit, ideally in writing the pricing to customers at the time the benefit is given, and then a list of eligible employees to make sure that the business [00:54:00] is compliant with those nondiscrimination rules. Speaking of for highly compensated employees, ensure that the benefit is offered on substantially the same terms to all other employees as well. And again, this should probably be documented in writing, likely in an employee manual. And be aware of related party issues if friends, adult children or extended family use the benefits of those services. So if you found value in this episode, please let me know by leaving and leaving [00:54:30] a review, liking the episode in your podcast application of choice or YouTube. If you're watching the video and for the next episode, we'll keep looking at section 132 with working condition, fringe benefits, and de minimis fringe benefits.