Fringe benefits for partners and S corporation shareholders

Employers can include certain nontaxable fringe benefits in employee compensation plans. These benefits supplement salaries, helping employers compete for valuable labor, while providing tax-free compensation to workers.

Self employed workers, including partners and S corporation >2% shareholders, can take advantage of some, but not all, fringe benefits available to employees. Educating clients about these benefits can generate additional tax planning opportunities while preventing mistakes and noncompliance.

In this article, I first provide a brief overview of nontaxable fringe benefits available to employees listed in §132 of the Internal Revenue Code (IRC). I then clarify which fringe benefits are available to partners and S corporation >2% shareholders.

Nontaxable fringe benefits available for employees

IRC §61(a)(1) defines gross income as “all income from whatever source derived, including (but not limited to)… Compensation for services, include fees, commissions, fringe benefits, and similar items.” Treas. Reg. §1.61–21(a)(1) lists several taxable fringe benefits:

• Employer-provided vacation

• Employer-provided automobile

• Flight on an employer-provided aircraft

• Employer-provided discount on property or services

• Employer-provided free or discounted commercial airline flight

• Employer-provided ticket to an entertainment or sporting event

• Employer-provided membership in a country club or other social club

However, later sections of the IRC exempt several common qualifying benefits:

• Health and accident insurance (IRC §106)

• Meals and lodging furnished for employer’s convenience (IRC §119)

• Cafeteria plans (IRC §125)

• Educational assistance programs (IRC §127)

• Dependent care (IRC §129)

• Certain listed fringe benefits (IRC §132)

• Disaster relief payments (IRC §139)

IRC §132 lists eight nontaxable fringe benefits:

1. No-additional-cost service (IRC §132(b); Treas. Reg. §1.132–2)

2. Qualified employee discount (IRC §132(c); Treas. Reg. §1.132–3)

3. Working condition fringe (IRC §132(d); Treas. Reg. §1.132–5)

4. De minimis fringe (IRC §132(e); Treas. Reg. §1.132–5)

5. Qualified transportation fringe (IRC §132(f); Treas. Reg. §1.132–6)

6. Qualified moving expense reimbursement (IRC §132(g))

7. Qualified retirement planning services (IRC §132(m))

8. Qualified military base realignment and closure fringe (IRC §132(n))

Accounting for fringe benefits for partners and S corporation >2% shareholders

Partners For purposes of fringe benefits, in Rev. Rul. 91–26 the IRS determined that partners are treated as self-employed, and the cash amount or value of benefits provided to them may be deducted by the partnership but must be reported as guaranteed payments for services to the recipient partner(s) under Treas. Reg. §1.707–1(c). Partners are generally unable to exclude guaranteed payments from gross income, unless a Code section specific allows partners to exclude the benefit.

S corporation >2% shareholders S corporations should generally treat shareholders active in the business as employees for payroll purposes (Rev. Raul 74–44). However, IRC §1372(a) specifically treats S corporations as partnerships and >2% shareholders as partners for purposes of employee fringe benefits.

Of the eight nontaxable fringe benefits listed in IRC §132, the following are specifically available to partners and S corporation >2% shareholders:

• No-additional-cost services, permitted by Treas. Reg. §1.132–1(b)(1). These are services ordinarily offered for sale to customers in the employer’s line of business in which the employee performs services, and the employer incurs no substantial additional cost in providing the service to the employee (IRC §132(b)).

• Qualified employee discounts, permitted by Treas. Reg. §1.132–1(b)(1). An employer may offer a reasonable employee discount for qualifying goods or services offered to customers in the ordinary course of the employer’s line of business of the employer in which the employee performs substantial services (IRC §132(c)).

• Working condition fringes, permitted by Treas. Reg. §1.132–1(b)(2). An employer may provide property or services to an employee of an employer to the extent that, if the employee paid for the property or service, the amount paid would be allowable as a deductible business expense under IRC §162 or §167, such as the business use of an employer-owned vehicle or cell phone (IRC §132(d)). (Also see IRS Notice 2011–72 for specific guidance on employer-provided cell phones.)

• De minimis fringes, permitted by Treas. Reg. §1.132–1(b)(4). An employer can provide property or services of relatively low value and frequency such that “accounting for it [is] unreasonable or administratively impracticable” (IRC §132(e)).

Note that certain fringes covered elsewhere or not de minimis cannot be excluded for employees, partners, or S corporation >2% shareholders. These include commuting use of employer-provided automobiles, private country club or athletic facility memberships, or use of employer-owned or leased facilities (e.g., apartment, lodge, boat).

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Advising clients on fringe benefits

Fringe benefits available to self-employed clients, including partners and S corporation >2% shareholders, provide additional tax planning opportunities. They also generate accounting and bookkeeping questions, either for adjusting journal entries or for paying expenses directly with business funds.

Partners and S corporations with multiple shareholders should also understand and consider how they will handle the provision of fringe benefits that may unequally affect them, especially when dealing with taxable benefits.

Finally, an accountable plan (Treas. Reg. §1.62–2) to reimburse small business owners for the business use of personal assets may provide an easier, more effective way to achieve an equivalent tax result. (An upcoming article discusses accountable plans.)