What Employers Need to Know About Taxing Benefits (Presentation)

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Presented by: Lorie Maring Phone: (404) 240-4225 Email: [email protected]

Please remember, employment and benefits law compliance depends on multiple factors – particularly those unique to each employer’s circumstances. Numerous laws, regulations, interpretations, administrative rulings, court decisions, and other authorities must be specifically evaluated in applying the topics covered by this webinar. The webinar is intended for general-information purposes only. It is not a comprehensive or all-inclusive explanation of the topics or concepts covered by the webinar. fisherphillips.com WHAT EMPLOYERS NEED TO KNOW ABOUT TAXING BENEFITS

Presented by: Lorie Maring Phone: (404) 240-4225 Email: [email protected]

fisherphillips.com GENERAL TAX PRINCIPLES APPLICABLE TO FRINGE BENEFITS

fisherphillips.com GENERAL TAX PRINCIPLES FRINGE BENEFITS

IRC Section 61 -- [G]ross income means all income from whatever source derived, including (but not limited to) . . . [c]ompensation for services, including fees, commissions, fringe benefits, and similar items

fisherphillips.com GENERAL TAX PRINCIPLES FRINGE BENEFITS What is a “Fringe Benefit”? A form of pay for the performance of services. For example, you provide an employee with a fringe benefit when you allow the employee to use a business vehicle to commute to and from work. • Term is not specifically defined anywhere in the IRC or the Treasury Regulations – • Some advisors distinguish between ERISA benefits and fringe benefits such as transportation or employee meals

fisherphillips.com GENERAL TAX PRINCIPLES FRINGE BENEFITS Performance of services. A person who performs services for you doesn't have to be your employee. A person may perform services for you as an independent contractor, partner, or director. Also, for fringe benefit purposes, treat a person who agrees not to perform services (such as under a covenant not to compete) as performing services.

fisherphillips.com GENERAL TAX PRINCIPLES FRINGE BENEFITS Provider of benefit. You’re the provider of a fringe benefit if it is provided for services performed for you. • You’re the provider even if a third party, such as your client or customer, provides the benefit to your employee for services the employee performs for you. (e.g. discounted day care provided by one of your clients to your employees)

fisherphillips.com GENERAL TAX PRINCIPLES FRINGE BENEFITS Recipient of benefit. The person who performs services for you is considered the recipient of a fringe benefit provided for those services. That person may be considered the recipient even if the benefit is provided to someone who didn't perform services for you. For example, your employee may be the recipient of a fringe benefit you provide to a member of the employee's family.

fisherphillips.com GENERAL TAX PRINCIPLES FRINGE BENEFITS Including taxable benefits in pay. You must include in a recipient's pay the amount by which the value of a fringe benefit is more than the sum of the following amounts. • Any amount the law excludes from pay. • Any amount the recipient paid for the benefit.

fisherphillips.com GENERAL TAX PRINCIPLES FRINGE BENEFITS Including taxable benefits in pay. If the recipient of a taxable fringe benefit is your employee, the benefit is subject to employment taxes and must be reported on Form W-2. If the recipient of a taxable fringe benefit isn't your employee, the benefit isn't subject to employment taxes. However, you may have to report the benefit on one of the following information returns. • An independent contractor: Form 1099-MISC, Miscellaneous Income • A partner: Schedule K-1 (Form 1065), Partner's Share of Income, Deductions, Credits, etc.

fisherphillips.com GENERAL TAX PRINCIPLES FRINGE BENEFITS Deducting taxable benefits. Employer’s reasonable cost of providing benefits is currently a tax-deductible business expense. Where there is income to the recipient – there is a generally deduction to the provider. In some cases, like group health insurance, there is a special rule allowing a deduction even when there is no income to the recipient…… but for how much longer???

fisherphillips.com EMPLOYMENT TAXES Why you want to get it right!

fisherphillips.com EMPLOYMENT TAXES APPLICABLE TO BENEFITS • Code §3401(a)1: This definition is the amount of compensation subject to tax withholding. • W-2 Wages (Code §§ 6041, 6051 and 6052 Compensation)2: In this definition, W-2 wages are calculated for the year and include the additional amounts of compensation, if any, that do not have income tax withheld. So, all compensation included in 3401(a) wages would also be included in W-2 wages; however, because certain income is exempt from income tax withholding, not all W-2 wages should be included in 3401(a) wages. • Taxable Fringe Benefits may be included in both W-2 and 3401 wages for withholding • Specific Exemptions Listed on Table 2-1 of publication 15-B • FICA and FUTA taxes also apply to fringe benefits • Exception if paid through 125 plan or otherwise exempt from tax under the Code

fisherphillips.com PENALTIES RELATED TO EMPLOYMENT TAX VIOLATIONS

• When a fringe benefit unexpectedly fails to qualify for its intended tax break, a variety of violations can occur • Failure to make employer contributions for FICA and FUTA • Failure to withhold and deposit taxes on behalf of employees • Failure to properly report employees’ taxable income • Each failure can trigger substantial penalties and some may result in multiple failures • Many of the penalties may be avoided if the employer can show that the failure was due to “reasonable cause” and not willful neglect

fisherphillips.com PENALTIES RELATED TO EMPLOYMENT TAX VIOLATIONS

• Failure to deposit penalty (Code Section 6656) – employer is required to deposit employment taxes either monthly or semi-weekly – the penalty ranges from 2% up to 15% of the underpayment depending on the circumstances • Failure to pay penalty (Code Section 6651(a)(3)) – employment tax return may be deficient if fringe benefits are not properly accounted for - penalty is .5% per month up to 25% of the tax due • Penalty for failure to provide correct information on an information return (Code Section 6721) W-2s may be incorrect – penalty is a maximum of $250 for each deficient return • Accuracy-related penalty (Code Section 6662) – applies to any portion of an underpayment that is attributable to negligence or disregard for rules or regulations – penalty is 20% of the portion of the underpayment to which the penalty applies

fisherphillips.com PENALTIES RELATED TO EMPLOYMENT TAX VIOLATIONS • Penalty for willful failures to collect, account for and pay tax (Code Section 6672) – “Trust fund recovery penalty” – imposed on individuals responsible for collecting, accounting for, and paying federal employment taxes – penalty is 100% of the unpaid tax • The IRS generally limits its collection efforts to the employer and other responsible persons but if the IRS were to seek to collect unpaid taxes from the employee with respect to the fringe benefits, it could create an employee-relations issue as well as potentially result in significant costs for the employer (i.e., costs of amending employee tax returns)

fisherphillips.com IDENTIFYING TAXABLE AND NON-TAXABLE FRINGE BENEFITS

IMPACT OF CAFETERIA PLANS

fisherphillips.com CAFETERIA PLAN

• A cafeteria plan, including an FSA, provides participants an opportunity to receive “qualified benefits” on a pre-tax basis. • It is a written plan that allows your employees to choose between receiving cash or taxable benefits, instead of certain qualified benefits for which the law provides an exclusion from wages if paid by the employer. • If an employee chooses to receive a qualified benefit under the cafeteria plan, the fact that the employee could have received cash or a taxable benefit instead won't make the qualified benefit taxable. • Doctrine of Constructive Receipt

fisherphillips.com CAFETERIA PLAN

. Qualified Benefits

Group health and accident benefits (some exceptions) Group term life insurance (employee’s life only) Adoption assistance Dependent care assistance (DCAP) Health savings account (HSA) Flexible spending arrangement (FSA) 401(k) Plan Cash option

fisherphillips.com CAFETERIA PLAN

. Non-qualified benefits

Educational assistance programs Scholarships Group term life insurance (other than employee’s life) Transportation reimbursements Archer medical savings accounts Long-term care insurance or services Health reimbursement arrangements (HRAs) Employer-provided meals and lodging Contributions to a Code Section 403(b) plan

fisherphillips.com CAFETERIA PLAN

. Employers must ensure that the cafeteria plan and all component benefits do not unduly favor the Highly Compensated Individuals (HCIs), Highly Compensated Employees (HCEs) and/or Key Employees with respect to either eligibility to participate or benefits offered and selected

Annual nondiscrimination testing required

HCI, HCE and Key Employee defined differently for different component benefits offered under a cafeteria plan

Using the wrong definition of HCI, HCE and Key Employee for any particular test could result in incorrect results

fisherphillips.com IDENTIFYING TAXABLE AND NON-TAXABLE FRINGE BENEFITS

fisherphillips.com TAXATION OF FRINGE BENEFITS • Fringe benefits include all benefits provided by an employer to its employees other than cash salary or wages – “de minimis fringe” is any property or service the value of which is so small as to make accounting for it unreasonable or administratively impracticable – a cash benefit is never de minimis. • Fringe benefits are generally subject to income and employment taxes unless the Internal Revenue Code provides a specific exclusion – Code Section 132 explicitly relates to fringe benefits but may overlap with other code sections – in the case of overlap, the more specific code section will apply (i.e., Code Section 129 applies to dependent care expenses – if the expenses don’t qualify under that section then they cannot be excluded under Code Section 132) • Fringe benefits are generally includable in an employee’s income in the tax year in which the benefits are actually or constructively received. • The amount included in an employee’s gross income is equal to the fair market value of the benefit – Code Section 61 provides extensive rules for valuation of certain taxable fringe benefits such as vehicle use, commuting expense, noncommercial and commercial airplane use and some meals fisherphillips.com TAXATION OF FRINGE BENEFITS • Generally, fringe benefits are subject to withholding and deposit obligations for employment taxes (income tax, FICA and FUTA) – employers who fail to properly identify and administer fringe benefits have significant compliance risk • Issues to consider with respect to employment taxes related to fringe benefits are the value assigned to the taxable fringe benefits and when the benefit is treated as paid • Cash payments are easy to value and are treated as paid when they are actually paid • Non-cash benefits are valued at fair market value and are treated as paid when the employer designates them as paid - no formal election required • Special rule allows the value of any benefits paid during the last two months of the year to be treated as paid during the following calendar year (may be used for some noncash taxable fringe benefits and not others and must be used for all employees receiving the benefit) • Employers should consider whether their fringe benefit program is required to comply with Code Section 409A relating to the taxation of nonqualifed deferred compensation

fisherphillips.com EXCLUDED FRINGE BENEFITS

• Accident and health benefits. • Group-term life insurance coverage. • Achievement awards. • Health savings accounts (HSAs). • Adoption assistance. • Lodging on your business premises. • Athletic facilities. • Meals. • De minimis (minimal) benefits. • Moving expense reimbursements. • Dependent care assistance. • No-additional-cost services. • Educational assistance. • Retirement planning services. Transportation (commuting) benefits. • Employee discounts. • • Tuition reduction. • Employee stock options. • Working condition benefits. • Employer-provided cell phones.

fisherphillips.com IDENTIFYING TAXABLE AND NON-TAXABLE FRINGE BENEFITS

ACCIDENT OR HEALTH BENEFITS

fisherphillips.com ACCIDENT OR HEALTH BENEFITS • This exclusion applies to contributions you make to an accident or health plan for an employee, including the following. • Contributions to the cost of accident or health insurance including qualified long-term care insurance. • Contributions to a separate trust or fund that directly or through insurance provides accident or health benefits. • Contributions to Archer MSAs or health savings accounts (discussed in Pub. 969). • This exclusion also applies to payments you directly or indirectly make to an employee under an accident or health plan for employees that are either of the following. Payments or reimbursements of medical expenses under 213(d) Payments for specific permanent injuries (such as the loss of the use of an arm or leg). The payments must be figured without regard to the period the employee is absent from work. Accident or health plan. This is an arrangement that provides benefits for your employees, their spouses, their dependents, and their children (under age 27 at the end of the tax year) in the event of personal injury or sickness. The plan may be insured or noninsured and doesn't need to be in writing. Includes disability and long-term care plans.

fisherphillips.com TAXATION OF GROUP HEALTH BENEFITS • Code Section 106 excludes from income the cost of coverage for an employee and an employee’s dependents under an accident or health plan attributable to employer contributions and employee pre-tax salary reductions through a cafeteria plan • Code Section 104(a) excludes from income amounts received through an accident or health plan for personal injuries or sickness that are paid for by the employee with after- tax dollars or for which the cost was included in the employee’s income • Code Section 105(b) excludes from income amounts received from an accident or health plan as reimbursement for expenses for medical care under Code Section 213(d) for an employee or an employee’s dependents that are attributable to employer contributions or employee pre-tax salary reductions through a cafeteria plan • Self-insured group health plans are subject to nondiscrimination requirements - group health plans may not discriminate in favor of HCEs with respect to eligibility to participate or benefits provided – insured plan non-discrimination rules under ACA on hold indefinitely

fisherphillips.com “MEDICAL CARE”

• An important concept related to the tax treatment of employer-sponsored group health benefits is the definition of medical care under Code Section 213(d) which includes: • Amounts paid for the diagnosis, cure, mitigation, treatment or prevention of disease, or for the purpose of affecting any structure or function of the body; • Expenses incurred primarily for the prevention or alleviation of a physical or mental defect or illness

• Specific examples of 213(d) medical expenses include: amounts paid for medical and dental care, hospital care, nursing care, x-rays, laboratory services, prescription drugs and prosthetic limbs fisherphillips.com ACCIDENT OR HEALTH BENEFITS • Employee. For this exclusion, treat the following individuals as employees. • A current common-law employee. • A full-time life insurance agent who is a current statutory employee. • A retired employee. • A former employee you maintain coverage for based on the employment relationship. • A widow or widower of an individual who died while an employee. • A widow or widower of a retired employee. • A leased employee who has provided services to you on a substantially full-time basis for at least a year if the services are performed under your primary direction or control • For certain government accident and health plans, payments to a deceased employee's beneficiary may qualify for the exclusion from gross income if the other requirements for exclusion are met.. • Not available for a 2% or more shareholder of an S corporation even if a W-2 employee • Applies to COBRA premiums paid on behalf of current or former employee

fisherphillips.com TAXATION OF FIXED INDEMNITY PLANS • A fixed indemnity health plan is an arrangement that typically pays a fixed dollar amount for certain health-related events (i.e., office visits, number of days spent in the hospital) – amounts paid are not directly related to the actual amount of the medical expenses incurred • Fixed indemnity coverage may be offered under a Section 125 cafeteria plan if the coverage qualifies for the exclusion from income under Code Section 106 for accident and health benefits and does not defer compensation. • Recent IRS guidance has created confusion regarding taxation • IRS views fixed indemnity as not meeting definition of “medical care”

fisherphillips.com TAXATION OF FIXED INDEMNITY PLANS • If the premiums for coverage under a fixed indemnity health plan are paid by the employer or the employee paid the premiums on a pre-tax basis through a Section 125 cafeteria plan, the benefit payments under the plan are taxable income and must be reported on Form W-2 (as well as counted towards the Cadillac Tax in 2020) • If the premiums for coverage under a fixed indemnity health plan are paid by the employee on an after-tax basis, the benefit payments under the plan are not taxable. • Administrative issues and concerns with new IRS position on fixed indemnity – some insurers resisting IRS position

fisherphillips.com TAXATION OF LONG-TERM CARE • You can exclude employer contributions to long-term care from the employee's wages subject to social security, Medicare, and FUTA taxes if benefits provided under a “qualified long-term care arrangement” • Amounts (other than policyholder dividends or premium refunds) received under a qualified long-term care insurance contract are treated as tax-free reimbursement of medical expenses within the meaning of Code Section 213(d) • If employee premiums are paid through a 125 plan (or FSA), employer contributions and benefits received are taxable • Financial limitations on the tax exclusion, including amount of premium and per diem benefits payable

fisherphillips.com TAXATION OF LONG-TERM CARE • A "qualified" long-term care insurance contract is one that: • provides coverage only for qualified long-term care services (necessary diagnostic, preventive, therapeutic, curing, treating, mitigating, and rehabilitative services and maintenance or personal care services that are required by a chronically ill person and are provided under a plan of care prescribed by a licensed health care practitioner); • does not pay benefits that duplicate those provided under Medicare (or that would be provided by Medicare but for application of a deductible or coinsurance amount); • is guaranteed renewable; • does not have a cash surrender value or other financial provision that may be paid, assigned, pledged as collateral for a loan, or borrowed by the policyholder; and • provides that all refunds of premiums and all policyholder dividends or similar amounts arising under the contract will be applied either to reduce future premiums or to increase benefits under the contract

fisherphillips.com TAXATION OF DISABILITY BENEFITS • Taxation of short-term and long-term disability benefits depends on how the premiums are paid during the year of the disabling event: • Paid with pre-tax dollars – benefits are taxable and subject to FICA withholding • Paid with after-tax dollars – benefits are not taxable • Paid with a combination of pre-tax and after-tax dollars – benefits are taxable on a pro-rata basis using a look-back period • The rules for disability benefits are different than those for group health plans paid for with pre-tax dollars because disability benefits are not amounts reimbursing expenses for medical care under Code Section 213 • Employers who offer pre-tax funding of disability coverage resulting in taxable disability payments must take care to count hours of service for those payment periods under ACA FT Employee determination

fisherphillips.com TAXATION OF WELLNESS PROGRAM REWARDS • Coverage and benefits paid under an employer-provided wellness program for medical care under Code Section 213(d) are generally excluded from an employee’s income • Any reward, incentive or other benefit provided under the wellness program that is not medical care under Code Section 213(d) is included in an employee’s income, unless it qualifies for exclusion as a fringe benefit under Code Section 132 or other applicable code section • Amounts paid by the employer to reimburse pre-tax premiums paid by an employee to participate in a wellness program are included in the employee’s income - many “FICA” savings programs abusing IRS rules

fisherphillips.com TAXATION OF WELLNESS PROGRAM REWARDS • Wellness rewards included in • Wellness rewards excluded from income: income: • Cash payments • Benefits, services and non-cash rewards for medical care (i.e., • Gift certificates biometric screenings, smoking • Non-cash benefits that are not cessation programs, health risk medical care (i.e., a gym assessments) membership) • De minimis fringe benefits (i.e., a t- • Payments or reimbursements for shirt) premiums paid through salary • HSA contributions through a reduction Section 125 plan (provided nondiscrimination rules are • Premium differentials satisfied)

fisherphillips.com IDENTIFYING TAXABLE AND NON-TAXABLE FRINGE BENEFITS

GROUP TERM LIFE

fisherphillips.com TAXATION OF SUPPLEMENTAL GROUP TERM LIFE INSURANCE

• Up to $50,000 of employer-provided group term life insurance may be excluded from an employee’s income – coverage amount is based on the amount of death proceeds • The cost of any amount of coverage in excess of $50,000 (less any amount paid by the employee with after-tax dollars) is treated as “imputed income” and is included in an employee’s income • Cost of coverage is determined using the IRS uniform table of life insurance rates which is based on age • Employers are required to report, but not withhold from, the imputed income for income tax purposes – employers are required to report and withhold FICA taxes – employers are not required to withhold FUTA taxes • Employers may deduct the amount of premiums paid for group-term life insurance on the life of the employee as ordinary and necessary business expenses • Group term life insurance must be provided on a nondiscriminatory basis - if not, “key employees” will not be permitted to exclude the cost of the first $50,000 of coverage from income (taxed at the greater of the IRS table value or the actual cost of the coverage)

fisherphillips.com IDENTIFYING TAXABLE AND NON-TAXABLE FRINGE BENEFITS

OTHER FRINGE BENEFITS