Notice of Proposed Rulemaking: Determination of Line of Business for Purposes of No-Additional-Cost Service and Qualified Employee Discount Fringe Benefits, 26 CFR Part 1, 90 Fed. Reg. 37824 (Aug. 6, 2025)
Available at https://www.govinfo.gov/content/pkg/FR-2025-08-06/pdf/2025-14883.pdf
The IRS has issued proposed rules that would update the method for determining an employer’s line of business for purposes of the employee income exclusion for no-additional-cost services and qualified employee discounts. The proposal would also modify the aggregation rules with respect to certain employees who work for employers with multiple lines of business. As background, under Code § 132(a), the value of certain fringe benefits—including no-additional-cost services and qualified employee discounts—may be excluded from an employee’s gross income if specified requirements are met. One requirement for these types of fringe benefits is that a substantial amount of the employee’s work must be for the same line of business from whence the benefits derive—that is, where the goods produced or services provided originate. (Other requirements include that the services or property be offered for sale to customers in the employer’s ordinary course of business, and limits on the percentage discount offered to employees.) Where exclusion requirements are not met, the value of these benefits must be included in the employee’s gross income for the year they are received.
Here are highlights of the proposed changes:
- Defining a Line of Business. The proposed regulations would eliminate use of the business classification system set forth in the Enterprise Standard Industrial Classification (ESIC) Manual (last updated in 1974) and substitute the North American Industry Classification System (NAICS) Manual, which is, incidentally, already in use by the IRS for other purposes. The preamble explains that the more modern and extensive NAICS Manual, updated every five years (most recently in 2022), allows for more granular representation of new and developing industries within which current lines of business may fall. For example, the NAICS includes industries not present in 1974, such as internet service providers, and smart phone application designers, and modernizes certain terminology. Both methods classify business establishments into industries using numeric codes that are used to determine lines of business for purposes of the exclusion. As an example, the IRS points out that categorization of a broadband internet service provider would be unclear under the ESIC Manual, but the 2022 NAICS Manual specifies the applicable four-digit category for this business.
- Aggregation Rules for Multiple Lines of Business. When an employer operates multiple primary lines of business that correspond with multiple industry codes, the aggregation rules provide guidance on which line of business applies for purposes of the exclusion. Generally, employers who operate more than one primary activity may treat multiple operations as a single line of business under certain circumstances, including where: (1) in the industry, it would be uncommon to operate one line of business separately from others , (2) many employees (except those at headquarters or main office) perform substantial services for more than one line of business, making it difficult to determine which line of business is their primary, and (3) for retail operations, the goods produced by separate lines of business on the same premises would be offered for sale together at a department store. The proposed regulations modify the retail operations aggregation rule by replacing the reference to “Department Store” with “General Merchandise Store (including Warehouse Clubs and Supercenters).” This change would acknowledge the changing landscape of retail, which now includes big box stores and other businesses that sell merchandise related to their primary service or goods (e.g., coffee and tea stores that also sell coffee makers or tea kettles). Other aggregation examples would also be updated.
If adopted, the final regulations would apply to taxable years beginning on or after the Federal Register publication date.
EBIA Comment: Switching from the ESIC Manual to the NAICS Manual may provide employers in more modern industries with greater accuracy in categorizing their lines of businesses to match their primary activities and increase opportunities for employees to qualify for the taxable income exclusion under Code §§ 132(a)(1) and (a)(2). Before the proposed rules are finalized, employers may want to compare their current lines of business and ESIC Manual industry codes to those available under the NAICS Manual to assess the impact of this change on the fringe benefits they offer employees. Consider also whether any resulting impact—including whether more time may be needed to prepare for these changes—warrants submitting a public comment (which must be received by November 4, 2025). For more information, see EBIA’s Fringe Benefits manual at Sections IX.B (“What Is a Qualified Employee Discount?”), IX.C.6 (“Line of Business”), and XXIV.B (“No-Additional-Cost Services”).
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