Field Attorney Advice Memorandum 20171202F (Jan. 13, 2017)
Available at https://www.irs.gov/pub/irs-lafa/20171202f.pdf
The IRS has released a heavily redacted Field Attorney Advice Memorandum that considers the tax consequences of a program that offers discounts to both employees and non-employees. The program allows employees to designate a specified number of individuals to receive a percentage discount off the published rates for the employer’s rental services. The discounts may be less than some discounts available on the open market and to certain customers. Employees can designate any person to receive the discount, regardless of the person’s relationship to the employee. The memo addresses three issues: (1) whether the discount is for property or services within the meaning of the Code § 132 exclusion for qualified employee discounts; (2) whether the discounts for non-employees prevent the employee discounts from being qualified employee discounts; and (3) whether the amount of any taxable excess discounts given to employees should be determined by comparison to the employer’s published rates or to the lower rates provided to some customers.
The memo does not disclose the exact nature of the employer’s business, but it does conclude that the employer’s rentals should be characterized as a service under Code § 132(c). Regarding the second issue, the memo notes that the qualified employee discount rules broadly define the term “employee” to include current and retired employees, employees who became disabled while working for the employer, spouses, and dependent children. Only individuals who come within that definition qualify for a nontaxable benefit. If an employee designates a non-employee to receive the discount, the employee will have taxable income equal to the value of any discount given to that designated non-employee, and the employer must collect and pay federal income tax withholding, FICA, and FUTA on that income. Finally, the memo observes that nontaxable qualified employee discounts on services cannot exceed 20% of the price at which the services are offered to the employer’s customers. The offering price that determines the 20% threshold can take into account discounts offered to discrete customer or consumer groups but only if sales at all such discounted prices are at least 35% of the employer’s gross sales for a representative period. Because this employer failed to provide sufficient information to determine whether that threshold was met and to establish the amount of discounts received by each customer group, the memo concludes that the taxable excess discount—and the withholding required on account of that excess—must be determined by the employer’s published rates.
EBIA Comment: This memo affirms that expanding participation in a discount program to non-employees does not adversely affect the discounts available to employees, although it imposes on the employer the administrative burden of collecting employment taxes on the non-employees’ benefits. While the memo does not indicate what the employer told its employees about the tax consequences of designating non-employees as discount recipients, we would expect any such program to carefully explain those consequences in advance. With respect to the discounts for employees, it is not clear why the employer did not provide the additional information necessary to use its discounted prices as a benchmark. But the lesson of that failure is clear: Absent sufficient evidence to establish a lower benchmark price, the IRS will calculate the taxable excess discount (and related employment tax liability) using an employer’s higher published rates. For more information, see EBIA’s Fringe Benefits manual at Section IX (“Qualified Employee Discount Programs”).
Contributing Editors: EBIA Staff.