Fringe Benefits and Employment Tax Update: A Potpourri of Issues Certain to Annoy Tax Departments American Gas Association Tax Meeting Marianna G. Dyson June 22, 2016
Topics du Jour Current employment tax examination climate Gift cards, prizes, and other fun stuff Single-claimant employment-related legal settlements The perils associated with the timing of FICA taxation under section 3121(v)(2) Miller & Chevalier Chartered 2
Employment Tax Examinations Analysis of National Research Program data is still ongoing IRS reports anecdotally that there is a lot of mischief going on Increased focus on fringe benefits provided to employees: accountable plans (including per diem payments) any perk treated as de minimis company cafeterias and/or meals provided during working hours Increased interaction between IRS corporate exam team and employment tax examiners coordination of issues direction of employment tax issues by IRS corporate exam team Miller & Chevalier Chartered 3
Employment Tax Examinations Automatic application of negligence penalties and proclivity towards assertion of information reporting penalties Detailed examinations of payments challenges to allocation between wages and non-wages in employmentrelated settlements failure to correctly report and allocate attorneys fees failure to timely solicit TINs before making payments (backup withholding) other backup withholding issues, including failure to timely deposit backup withholdings and to file Form 945/945A Miller & Chevalier Chartered 4
Gift Cards (and Other Fun Stuff) Provided to Employees Miller & Chevalier Chartered 5
De Minimis Fringe Benefits Applicable Statutory Provisions IRC 102(c): Gifts made to employees are not excludable. IRC 132(a)(4): Gross income shall not include any fringe benefit which qualifies as a de minimis fringe. IRC 132(e)(1): The term de minimis fringe means any property or service the value of which is (after taking into account the frequency with which similar fringes are provided by the employer to the employer s employees) so small as to make accounting for it unreasonable or administratively impracticable. Miller & Chevalier Chartered 6
Gift Cards: Administrability Condition Reg. 1.132-6(b) Unless excluded by another Code provision, the value of any fringe benefit that would not be unreasonable or administratively impracticable to account for is includible in the employee's gross income. This is the tool being used by the IRS to shrink the availability of the de minimis fringe benefit exclusion. TAMs 200030001 and 9148001; FSA 200219005 ; and American Airlines, Inc. v. US, 40 Fed. Cl. 712 (1998), aff'd 204 F.3d 1103 ( Fed. Cir. 2000). Miller & Chevalier Chartered 7
Limitation on Cash and Cash Equivalents Reg. 1.132-6(c) With the exception of occasional meal money or local transportation fare, cash is never excludable as a de minimis fringe benefit. Similarly, a cash equivalent fringe benefit (such as one provided to an employee through the use of a gift certificate or charge or credit card) is generally not excludable even if the same property or service acquired (if provided in kind) would be excludable as a de minimis fringe benefit. The IRS ignores the presence of generally in the regulation. Miller & Chevalier Chartered 8
Gift Cards and Gift Certificates In TAM 200437030, the IRS National Office concluded that a $35 employer-provided gift coupon redeemable at grocery stores for a holiday gift is not excludable as a de minimis fringe because cash and cash equivalent fringe benefits like gift certificates have a readily ascertainable value, [and therefore] they do not constitute de minimis fringe benefits because these items are not unreasonable or administratively impracticable to account for. Miller & Chevalier Chartered 9
Gift Cards and Gift Certificates (cont d) The IRS reached this conclusion in TAM 200437030 despite the fact that: (1) the listed grocery store reserved the right not to accept the coupon; (2) the coupon could only be used once with any unused portion of its value forfeited; and (3) the coupon was issued to specific employees requiring them to sign their name on the back of the coupon (similar to a check). Miller & Chevalier Chartered 10
Can a Gift Certificate Qualify as Tangible Personal Property? Yes, under Prop. Reg. 1.274-8(c)(2) (pertaining to length-ofservice and safety achievement awards), a gift certificate may qualify as tangible personal property if it is inscribed with the recipient s name, is nontransferable, and cannot be redeemed for cash. This provision was cited favorably by the lower court in American Airlines, 40 Fed. Cl. 712 (1998) (a nonnegotiable certificate conferring only the right to receive tangible personal property is not equivalent to cash). Miller & Chevalier Chartered 11
Raffles, Prizes, and Sporting Event Tickets Employer must apply the three elements to determine whether de minimis: value, frequency and administrability. If prize is won or given to employee and the value is not excludable as de minimis, the value must be treated as additional wages and subjected to payroll taxes. Cannot simply report income on Form 1099-MISC. Issue of prize being provided by a third party that is not the common law employer -- 1.61-21(a)(5) and 3401(d)(1) definitions of employer. Sporting event tickets Policy for how many can be provided to each employee and tracking of same. Issue of distribution being controlled by C suite and IRS assumption that availability to executives triggers wage inclusion. Miller & Chevalier Chartered 12
Federal Liability for Failing to Treat a Taxable Fringe Benefit as Wages Employer is secondarily liable ( 3403) for failing to withhold income taxes and will be assessed: 25% (currently) with respect to additional wages paid to employees receiving less than $1 million in supplemental wages in the aggregate during the year, and 39.6% (currently) for additional supplemental wages in the aggregate equal or exceeding $1 million during the year. Employer is secondarily liable for failing to withhold the employee s share of FICA taxes (6.2% OASDI up to annual wage base, 1.45% Medicare, + AdMedTax on high earners). Employer is liable for failing to pay its share of FICA taxes (6.2% OASDI up to annual wage base + 1.45% Medicare). Miller & Chevalier Chartered 13
Federal Liability for Failing to Treat a Taxable Fringe Benefit as Wages (cont d) Employer is liable for FUTA taxes to extent employee s other wages are not over the annual FUTA tax wage base. Employer is liable for 6656 late deposit penalty on its share of FICA taxes only (i.e., 10% of FICA taxes it should have paid). Information reporting penalties under 6721/6722 ($250 each, but sometimes only one penalty is assessed). Negligence penalty of 20% under 6662 is routinely asserted by Exam but is not often sustained in Appeals. Interest, but only if assessment is not paid timely under the interest-free adjustment rules of 6205. Miller & Chevalier Chartered 14
Self-Correction Strategies Interest-free adjustment rules of 6205(a)(1) and Treas. Reg. 31.6205-1 provide rules for the adjustments of income tax withholding and FICA taxes without interest. Employers have the opportunity to correct underreporting errors through the Form 941-X process, interest free, if the taxes are paid by the due date of the return for the quarter in which the error was ascertained. Employer may self-correct FICA taxes for all open years, but cannot self-correct an income tax withholding failure from an earlier open year; employer may, however, issue Forms W-2c to report more wages in Box 1. Employer should decide whether or not to take advantage of voluntary correction rules for past failures to treat taxable de minimis fringes as wages, to include contacting the IRS. Correct tax treatment going forward don t wait for the IRS examination. Miller & Chevalier Chartered 15
Single-Claimant Employment-Related Legal Settlements Miller & Chevalier Chartered 16
Single-Claimant Employment-Related Settlements Approach for Analyzing Tax and Reporting Treatment Withholding for and reporting of an employment-related settlement and court-awarded payments involves a 4-step analysis: Determine the nature of the payments and character of the underlying claims begin resolved Determine whether the payments are items of gross income or are not income Determine whether the income payments are wages or non-wages Determine the corresponding reporting (and withholding) (Form 1099 or Form W-2), including reporting on payments to the plaintiff s attorney Miller & Chevalier Chartered 17
Section 104(a)(2) Exclusion for Damages Limits on Excludability of Settlement and Award Payments 104(a)(2) excludes from gross income only the amount of any damages (other than punitive damages) received... on account of personal physical injuries or physical sickness. Damages for personal physical injuries or physical sickness, including emotional distress and loss of earnings resulting from the physical injuries or sickness, are excludable from income. In cases of non-physical injuries (such as discrimination, harassment or other violation of a constitutional or personal right), amounts excludable for emotional distress are limited to out-of-pocket medical expenses. Miller & Chevalier Chartered 18
Single-Claimant Employment-Related Settlements Nature and Character of the Payments The nature and character of the elements of a settlement payment are determined under the so-called origin of the claim doctrine-- In lieu of what was the payment made? Determine how to allocate the payments Between compensation for physical injury ( 104(a)(2)) and compensation other than for physical injury. For compensation other than for physical injury, allocate between wages (subject to payroll taxation) and non-wage amounts (e.g., interest, punitive damages, emotional distress other than consequential damages for physical injury, and attorney s fees). Miller & Chevalier Chartered 19
Single-Claimant Employment-Related Settlements Nature and Character of the Payments The IRS will generally accept the allocations in a court judgment award, and the parties allocation to the various types of recovery in a settlement agreement, if the settlement appears to be bona fide and reasonable. If the settlement allocation does not reasonably reflect the underlying claims, however, the IRS will look to all of the facts and circumstances of the underlying claims, will dispute the parties allocations and generally reallocate to wages (e.g., assess payroll taxes). Miller & Chevalier Chartered 20
Single-Claimant Employment Related Settlements Audit Focus on Non-Wage Treatment of Attorneys Fees Reimbursement of claimant s attorney s fees in an employment-related case If clearly designated in a court award pursuant to a fee-shifting statute, defendant s payment to plaintiff s attorney (law firm) is not wages. Report on Form 1099-MISC, Box 3 (no FITW or FICA). There is uncertainty as to whether attorney s fees recovered in a settlement between the parties in an action under a fee-shifting statute are excluded from wages, e.g., in a suit to recover back wages and attorneys fees. Miller & Chevalier Chartered 21
Reporting of Payments to Attorneys Section 6045(f) Every person making payments aggregating $600 or more during a calendar year in the course of a trade or business to an attorney (including a law firm) is required to report the payments on Form 1099-MISC regardless of whether the payments constitute income to the attorney or income to the attorney s client. Backup withholding by the payor is required if the attorney fails to provide a TIN prior to the time of payment. Miller & Chevalier Chartered 22
Reporting of Payments to Attorneys Section 6045(f) reporting will generally be triggered in the context of an employment-related settlement if the company s payment pursuant to the court award or settlement is routed through the plaintiff s attorney (or to the company s attorney for transmission to the plaintiff or the plaintiff s attorney). Reporting of the gross amounts of payments to attorneys is separate from the company s wage or information reporting (Form W-2 or Form 1099) to the plaintiff. Miller & Chevalier Chartered 23
Reporting of Payments to Attorneys Reporting of payments to an attorney under 6045(f) is made on Form 1099, Box 14. There are special rules in 1.6045-5(b) that should be reviewed for situations involving joint or multiple payees. Remember that it may also be necessary to report the attorneys fees on a Form 1099-MISC issued to the claimant, if there is not a fee-shifting statute. Miller & Chevalier Chartered 24
Using ERISA as the Basis of a Private Cause of Action for Failing to Properly Apply FICA Taxes to Deferred Compensation Miller & Chevalier Chartered 25
Special FICA Timing Rule Applicable to NQDC Failure to Apply 3121(v)(2) Results in FICA Taxation at Distribution Under 3121(a), wages are subjected to FICA taxation when constructively or actually received. This is known as the general timing rule and it coincides with the application of income tax withholding. 3121(v)(2) mandates that amounts deferred under a nonqualified deferred compensation plan must be subjected to FICA taxation as of the later of the date the services were performed or the date on which there is no substantial risk of forfeiture. The application of 3121(a) is not elective! Miller & Chevalier Chartered 26
Special FICA Timing Rule Applicable to NQDC Failure to Apply 3121(v)(2) Results in FICA Taxation at Distribution If properly applied, the deferred comp and subsequent increases in its present value escape FICA taxation at distribution under the nonduplication rule. Application of 3121(v)(2) often viewed as favorable, because FICA taxation occurs in a year when employee s other wages exceed OASDI wage base. If not properly applied, employer may retroactively correct open years and IRS may assess FICA taxes for those years. Otherwise, FICA taxation occurs at distribution under general timing rule. Regs do not permit employer to correct closed years failures!! Miller & Chevalier Chartered 27
Davidson v. Henkel (January 6, 2015) Private Cause of Action Under ERISA for Failing to FICA Tax Properly Henkel maintained a SERP, which is a nonaccount balance plan under 3121(v)(2) regulations. FICA taxes are usually applied to the present value of the SERP benefits when the employee retires, i.e., when all events are known that allow the value of the lifetime retirement benefit to be reasonably ascertainable. An outside advisor told Henkel that it had failed to subject the present value of the SERP benefits to FICA taxation at retirement. Henkel also was not FICA taxing the distributions. Miller & Chevalier Chartered 28
Davidson v. Henkel (January 6, 2015) Three Ill-Advised Actions That Led Retirees to Seek a Remedy Under ERISA Henkel settled with the IRS without the retirees knowledge and began withholding FICA taxes at distribution under the general timing rule (with no gross up). In addition, Henkel withheld from distributions the employees shares of FICA taxes that it had paid to the IRS under the settlement. Henkel admitted to Davidson in writing, yes, at the time you commenced receipt of this benefit, Henkel should have applied FICA tax to the present value of your nonqualified pension benefit. Miller & Chevalier Chartered 29
Davidson v. Henkel (January 6, 2015) Private Cause of Action Under ERISA for Failing to FICA Tax Properly 2012: U.S. district court certified a class of 49 retirees; case was allowed to move forward on the premise that the Henkel SERP was governed by ERISA. Earlier this year, the court held that an employer s promise under a top hat plan to provide a stated benefit carried with it an obligation to administer the plan in a manner that essentially guaranteed the proper tax treatment of benefits under FICA. Henkel paid the benefits required by the plan formula, but, by its own admission, failed to withhold FICA taxes under the special timing rule of 3121(v)(2). Miller & Chevalier Chartered 30
Davidson v. Henkel (cont d) The court held Henkel liable under ERISA, because its failure to apply FICA taxes at the time of each employee s retirement required the application of FICA taxation at payment, which diminished the retirees net benefits. Indemnification protection under 3102(b) does not help when employer failed to apply 3121(v)(2). Because the application of the special timing rule of 3121(v)(2) is exceedingly complex, it is not uncommon for employers to make mistakes in the application of this rule. Miller & Chevalier Chartered 31
Davidson v. Henkel (cont d) The decision in Henkel may open the door to employees who feel aggrieved by their employer s mistakes to sue under ERISA for recovery of their lost tax benefits. Thus, the decision highlights a very real threat facing a sponsoring employer of a top-hat plan if it fails to administer the plan in a manner that results in the most beneficial tax treatment. Takeaway for employers: Review the FICA tax procedures being applied to your nonqualified deferred comp arrangements. Miller & Chevalier Chartered 32
Miller & Chevalier s New Tax Withholding & Reporting Blog: TWRBlog.com www.twrblog.com Topics include: Employment taxes, including federal and state income tax withholding and Federal Insurance Contributions Act (FICA) taxes Form 1099 reporting, including 1099-MISC, 1099-K, 1099-B, and others in the 1099 series Backup withholding Withholding and reporting on payments to nonresident alien individuals and foreign corporations under Chapter 3 Foreign Account Tax Compliance Act reporting and withholding under Chapter 4 Affordable Care Act information reporting requirements for applicable large employers and providers of minimum essential coverage State reporting and withholding requirements such as California s withholding requirements for payments to non-california residents and similar requirements in South Carolina and Nebraska Worker classification issues Miller & Chevalier Chartered 33
Contact Information For additional information, please contact: Marianna G. Dyson (202) 626-5867 mdyson@milchev.com Miller & Chevalier Chartered 34