marianna g. dyson mdyson@milchev (202) 626-5867

m i l l e r & c h e v a l i e r Chartered

Tax Executives InstituteOmaha Chapter

Hot Topics: Fringe Benefitsand Employment Taxes

October 18, 2006

Marianna G. [email protected] (202) 626-5867

Covered Topics

1. Update on Examinations of Employer-Provided Fringe Benefits.

2. Cellular Telephones and Related Services.

3. Accountable Plans.

4. Personal Use of Company Aircraft.

5. Final Regs on Supplemental Wage Withholding Requirements.

6. Tax Treatment of Home Sale Expenditures for Relocating Employees.

7. “Murphy’s Law and the Tax Treatment of Damages for Non-Physical Injuries.”

8. 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.


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;


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

Specifically Identified Fringe Benefits in Audit Techniques Guide.


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.


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).


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.


10 (Loser) Arguments to Justify No Reporting of Fringe Benefits

1. There’s no cost to the employer.

2. The employer did not claim a deduction for the cost of the fringe benefit.

3. The benefit was not provided, arranged, and/or known by the employer.

4. The employer made the employee take the benefit.

5. Provision of the benefit lowered other tax deductible expenses of the employer.

6. The employee is not having fun.

7. The benefit is worthless.

8. Nobody reports this benefit (or government employees don’t pay tax on this benefit.

9. The IRS issues hundreds of PLRs per year, which have little or no value as precedent, and we only violated one of them.

10. 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.


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


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 purpose of 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).


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.


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.


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%


Final Regulations Published on July 25, 2006 “Supplemental Wages” Defined - essentially, any wages

that are not regular wages. Examples include:BonusesOvertime payTipsBack payCommissionsWages paid under reimbursement or other expense

allowance arrangements


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


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


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.


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.


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.


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.


Statutory Stock Option Consequences.ISO pricing requirement.ESPP pricing requirement.Consequences of violating pricing

requirement.


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.


Section 409A Consequences.Pricing requirement for purposes of stock

option exception.Consequences of violating pricing

requirement.Dealing with “bad” options.


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.


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.

m i l l e r & c h e v a l i e r Chartered

For Further InformationPlease Contact:

Marianna G. Dyson(202) 626-5867

[email protected]

marianna g. dyson mdyson@milchev (202) 626-5867

Documents

fringe benefits instructions

reporting of fringe

examinations of employer

fringe benefitsskyboxesawards

fringe benefitsspecifically

fringe benefitstopics

fringe benefitsinstructions

posttermination benefits