Tax Executives InstituteOmaha ChapterHot Topics: Fringe Benefitsand Employment TaxesOctober 18, 2006 Marianna G. Dyson firstname.lastname@example.org (202) 626-5867
Covered Topics • Update on Examinations of Employer-Provided Fringe Benefits. • Cellular Telephones and Related Services. • Accountable Plans. • Personal Use of Company Aircraft. • Final Regs on Supplemental Wage Withholding Requirements. • Tax Treatment of Home Sale Expenditures for Relocating Employees. • “Murphy’s Law and the Tax Treatment of Damages for Non-Physical Injuries.” • Tax Issues Arising in Connection with Option Backdating.
Update on Examinations of Employer-Provided Fringe Benefits Topics Covered by this Section • Favorite Themes in the Fringe Benefits Audit Techniques Guide – Fun, Food, and Moving Around. • Background and Steps to Analyze Fringe Benefits • Specifically Identified Fringe Benefits in the Audit Techniques Guide. • Instructions to IRS Examiners Regarding How to Identify Fringe Benefits. • 10 (Loser) Arguments to Justify No-Reporting of Fringe Benefits.
Update on Examinations of Employer-Provided Fringe Benefits • Audit Guide Themes - Fun, Food, and Moving Around. • deduction disallowances under sections 274 and 162(m), in addition to the failure to impute and report income; • Entertainment (e.g., personal travel, club memberships, vacations); • Spousal travel benefits; • Accountable plans under section 62(c) (including misuse of corporate credit cards); • Loans; • Meals;
Update on Examinations of Employer-Provided Fringe Benefits • Audit Guide Themes - Fun, Food, and Moving Around Cont’d. • Post-termination benefits, including the taking or keeping of property and participation in discount programs following termination of employment; • Use of employer-provided transportation (cars, chauffeurs, and airplanes); • Personal use of other listed property (laptops, cellular phones, and similar telecommunications equipment); and • Security (transportation and home improvements).
Skyboxes Awards and bonuses Club memberships Corporate credit cards Executive dining room Loans Outplacement services Security-related transportation Spousal/Dep life insurance Transportation Chauffeurs Employer-paid parking Transfer of property EE use of listed property (cell phones) Relocation expenses Non-commercial air travel Employer-paid vacations Dependent travel Wealth Management Qualified retirement planning Update on Examinations of Employer-Provided Fringe Benefits • Specifically Identified Fringe Benefits in Audit Techniques Guide.
Update on Examinations of Employer-Provided Fringe Benefits Instructions to IRS Examiners on How to Identify Fringes • Check Form 10-K and Form 4 • Form 1120 line items (e.g., travel and entertainment, etc.) • Request list of 16b executives • Executives returns are also frequently requested • IRS examiners are also asked to take the following steps: • Identify the department responsible for approving and processing payments to executives and officers • Review the Executive Compensation Committee minutes, reports, etc.
Update on Examinations of Employer-Provided Fringe Benefits Instructions to IRS Examiners on How to Identify Fringes Cont’d • Review loan agreements between the corporation and executives/officers. • Identify all payments to, or on behalf of, the executives/officers. • Inspect the employment contracts and/or severance agreements to identify salaries and benefits paid to the executives. • Sample monthly expense reports submitted by executives, to include determining if there is an accountable plan and if the plan meets the requirements of IRC § 62(c).
Update on Examinations of Employer-Provided Fringe Benefits Instructions to IRS Examiners on How to Identify Fringes Cont’d • Search for the executive's name, SSN, or title in Accounts Payable, to include identifying payments to executives that were not included on a Form W-2 or Form 1099. • Request a listing of the specific payroll codes or other accounting codes that relate to expenses/expenditures for executives. These codes can be used to identify payments to the executives/officers that may be taxable as compensation.
Update on Examinations of Employer-Provided Fringe Benefits 10 (Loser) Arguments to Justify No Reporting of Fringe Benefits • There’s no cost to the employer. • The employer did not claim a deduction for the cost of the fringe benefit. • The benefit was not provided, arranged, and/or known by the employer. • The employer made the employee take the benefit. • Provision of the benefit lowered other tax deductible expenses of the employer. • The employee is not having fun. • The benefit is worthless. • Nobody reports this benefit (or government employees don’t pay tax on this benefit. • The IRS issues hundreds of PLRs per year, which have little or no value as precedent, and we only violated one of them. • The law is too confusing.
Cellular Telephones and Related Services Topics Covered by this Section • Statutory Characterization as “Listed Property” Imposes Detailed Recordkeeping Requirements. • Unlike Vehicles, No Streamlined Substantiation Rules Are Available for Cell Phones. • Recent IRS Examination Activity.
Cellular Telephones and Related Services • Statutory characterization of “listed property” imposes detailed recordkeeping requirements. • Section 280F(d)(4)(A)(v) of the Code. • Interaction with section 274(d)(4) of the Code. • Related expenses. • Interaction of working condition fringe exclusion and accountable plan rules. • No records = taxation
Cellular Telephones and Related Services • No streamlined substantiation rules for cell phones. • No personal use or de minimis personal use policies are authorized under the section 274(d) substantiation rules. • Sampling is permitted but administratively difficult. • Recent IRS examination activity. • Recent case law support IRS position. • Reference to cell phones in IRS Audit Techniques Guide on Fringe Benefits.
Employee Business Expense Reimbursement Arrangements – “Accountable Plans” • Reporting, withholding, and deduction of employee business expenses. • Reimbursement reporting requirements for standard expense accounts that are “accountable plans.” • Per diem arrangements. • Car allowance plans. • Mileage allowances. • Runzheimer-type plans.
What is an “accountable plan” under IRS rules? • The plan (and any payments, allowances, or reimbursements under the plan) must meet the following requirements in order to be “accountable,” i.e., tax-free— • Business connection: the amounts must be paid for business expenses paid or incurred by EE in connection with employment. • Substantiation: the amounts paid must be “substantiated” by EE within a “reasonable period of time” after expense is paid or incurred. • Return of spare change: EE must be required to return, within a “reasonable period of time” any excess part of an advance.
Where did the idea of accountable plans come from? • Congress – The Family Support Act of 1988. • Concerns about taxpayers “tunneling under 2% floor” following the changes enacted by the Tax Reform Act of 1986. • Extensive legislative history setting forth guidance for accountable plans: • “The Congress viewed an ER’s agreement to reimburse certain expenditures pursuant to such an arrangement as evidence that the item was a bona fide, ordinary, and necessary expense of the ER’s business, and that in effect the EE was acting as an agent of the ER in paying for the item.” • IRS felt empowered to implement strict rules in the 1989 final regulations.
What does it mean to have an accountable plan? • If payments, allowances or reimbursements for business expenses are made under an accountable plan and the EE meets all the business connection, substantiation, and return of spare change requirements with respect to the expenses, the amounts are excludable from EEs’ income for Form W-2 reporting and payroll tax purposes.
What does it mean to have a nonaccountable plan? • If the employer’s (“ER”) business expense plan does not meet all of the requirements, the IRS is permitted to take the position under an “anti-abuse” rule that the entire plan fails as an accountable plan and, consequently, all the payments under the plan must be treated as wages subject to employment taxation. In other words, retroactive payroll taxes (i.e., Federal income tax withholding and FICA taxes) could be assessed against the ER.
Taxation of Reimbursements under Accountable Plan Rules • What happens if an EE submits a request for payment or reimbursement of a business expense, but that particular request fails to meet all the requirements of the otherwise accountable plan? • If all the requirements are not met—for example, the expense is not a deductible business expense or the employee fails to timely substantiate the business nature of the expense—the reimbursement is fully taxable to the EE and is subject to payroll tax withholding.
When is an expense a business expense meeting the business connection requirement? • A business expense is one that is deductible, because it was incurred in connection with the performance of services as an EE of the ER, such as transportation, meals and lodging, phone calls, tips, laundry, and taxi fares incurred while away from home overnight on business.
What happens if the ER reimburses the EE for a business-related expense that is nondeductible? • The accountable plan rules permit the reimbursement of bona fide nondeductible business expenses without jeopardizing the overall plan. For example, an EE’s meal expenses while traveling on a day trip would not be deductible business expenses, but are still expenses incurred for valid business purposes. Thus, the ER may reimburse the expenses, but they must be treated as wages and subjected to payroll taxes.
What are the elements of substantiation? • There must be adequate records or sufficient evidence as to— • the amount of the expense, • the time and place of the travel, entertainment, amusement, recreation, or use of any “listed” property (e.g., cars, planes, cell phones, and entertainment facilities), • the business reason for the expense or nature of the business benefit derived or expected to be derived” from the expense (i.e., the business purposeof the expense), and • the business relationship to the ER of any persons entertained. • The “business relationship” information requires not only of the person’s name and organization, but also of his “title or other designation” sufficient to establish the business connection.
Personal Use of Corporate Aircraft Topics Covered by this Section • Focus on Characterization of Flights for Fringe Benefits Purposes Following AJCA Changes to Deduction Disallowance Rules in Section 274(e)(2). • The Special Valuation Rule for Personal Use of Company Aircraft (“SIFL” Method).
Personal Use of Corporate Aircraft • Focus on Characterization of Flights for Fringe Benefits Purposes Following AJCA Changes to Deduction Disallowance Rules in Section 274(e)(2). • Statutory override of Sutherland Lumber - Section 274(e)(2) limitation on the deduction for expenses for entertainment goods, services, and facilities (including airplanes) provided to “specified individuals.” • Allocation method imposed by Notice 2005-45 – occupied seat analysis.
Personal Use of Corporate Aircraft • The Special Valuation Rule for Personal Use of Company Aircraft (“SIFL” Method). • Consistency requirement for Standard Industrial Fair Level (“SIFL”). • “Control employee” definition. • Additional valuation rule triggered when at least 50% of regular seating capacity of aircraft is occupied by business passengers. • Valuing side trips. • Security exclusion. • Double hammer when entertainment flights are mischaracterized as business flights. • Spousal travel – competing deduction disallowance provision.
Supplemental Wage Withholding Regulations Topics Covered In This Section • Increased Supplemental Withholding Rate Enacted by § 904 of AJCA • Final Regulations Published on July 25, 2006 • Effective Date of Regulations.
Supplemental Wage Withholding Regulations • Increased Supplemental Withholding Rate Enacted by § 904 of AJCA • Rate of withholding increased on supplemental wages exceeding $1 million to equal the highest individual marginal tax rate • Highest individual marginal rate is currently 35%
Supplemental Wage Withholding Regulations • Final Regulations Published on July 25, 2006 • “Supplemental Wages” Defined - essentially, any wages that are not regular wages. Examples include: • Bonuses • Overtime pay • Tips • Back pay • Commissions • Wages paid under reimbursement or other expense allowance arrangements
Supplemental Wage Withholding Regulations • Examples of supplemental wages, Cont’d. • Taxable nonqualified deferred compensation • Taxable noncash fringe benefits • Sick pay paid by a third party as the employer’s agent • Amounts includible under § 409A • Income from exercise of nonqualified stock options • Wages recognized on the lapse of a restriction on restricted property transferred from employer to employee
Supplemental Wage Withholding Regulations • Payments that are not wages subject to income tax withholding are neither regular wages nor supplemental wages • Example: Income from the disqualifying disposition of qualified stock options • Exception to treat tips and overtime pay as regular wages
Supplemental Wage Withholding Regulations • Calculation of withholding amount on supplemental wages: • Supplemental wage payments when the aggregate supplemental wages during the year exceeds $1 million. • De minimis exception for certain payments made by agents.
Supplemental Wage Withholding Regulations • Calculation of withholding amount on supplemental wages (Cont’d): • Supplemental wage payments when the aggregate supplemental wages during the year does not exceed $1 million. • The aggregate procedure (applying the employee’s Form W-4 to the supplemental wage payment). • Optional flat rate withholding • Post-termination wage payments.
Supplemental Wage Withholding Regulations • Rule for employers within the same controlled group. • Application of mandatory flat rate withholding regardless of employee’s personal income tax liability. • Vigorous rejection of comments requesting an exception for mandatory withholding when employee is eligible for offsetting income tax credit or deduction.
Supplemental Wage Withholding Regulations • Effective Date of Final Regulations • Statute was effective for payments made after December 31, 2004. • Final regulations made effective January 1, 2007 to “give employers time to implement any programming and coordination by the final regulations.”
Tax Treatment of Home Sale Expenses for Relocating Employees Topics Covered by this Section • Focus of Rev. Rul. 2005-74, 2005-51 I.R.B. 1153. • Rev. Rul. 2005-74 Does Not Address the Deduction Treatment of Losses on Sales.
Tax Treatment of Home Sale Expenses for Relocating Employees • Focus of Rev. Rul. 2005-74, 2005-51 I.R.B. 1153 • Situation 1 – appraised value arrangement. • Situation 2 – amended value or buyer value option. • Situation 3 – amended value arrangement. • Rev. Rul. 2005-74 Does Not Address the Deduction Treatment of Losses on Sales. • IRS position. • Taxpayers’ position. • Response of TAM 9036003 • Axar Nut.
Murphy’s Law – Tax Treatment of Damages for Non-Physical Injuries • D.C. Circuit holds that damages for non-physical injures ≠ income under 16th Amendment. • Reactions to Murphy decision. • “Human capital” argument. • Interplay between the 16th Amendment and Congressional power to tax under Art. I, section 8. • Potential misuse by tax protestors. • Petition for rehearing en banc filed October 5. 2006.
Tax Issues Arising in Connection with Option Backdating Topics Covered In This Section • Statutory Stock Option Consequences. • Section 162(m) Deduction Limit Consequences. • Section 409A Consequences. • Potential for Unintentional Backdating.
Tax Issues Arising in Connection with Option Backdating • Statutory Stock Option Consequences. • ISO pricing requirement. • ESPP pricing requirement. • Consequences of violating pricing requirement.
Tax Issues Arising in Connection with Option Backdating • Section 162(m) Deduction Limit Consequences. • Pricing requirement for purposes of qualified performance-based compensation exception. • Consequences of violating pricing requirement. • Dealing with “bad” options.
Tax Issues Arising in Connection with Option Backdating • Section 409A Consequences. • Pricing requirement for purposes of stock option exception. • Consequences of violating pricing requirement. • Dealing with “bad” options.
Tax Issues Arising in Connection with Option Backdating • Potential for Unintentional Backdating. • Treas. Reg. sec. 1.421-1(c)(1): A corporate action constituting an offer of stock for sale is not considered complete until the date on which the maximum number of shares that can be purchased under the option and the minimum option price are fixed or determinable.
Tax Issues Arising in Connection with Option Backdating • Potential for Unintentional Backdating. • Fact patterns that might be of interest to IRS. • Oral award of options, with documentation completed later. • Award authority delegated within specific parameters, with appropriate approvals obtained at later date.
For Further InformationPlease Contact: Marianna G. Dyson(202) email@example.com