Employee fringe benefits generally consist of property or services provided directly or indirectly to or for an employee as a salary or wage supplement. One of the advantages of a C corporation is that it permits an owner/employee of the business to participate in certain fringe benefits provided for employees and receive the same favorable tax benefits. The value of many of these benefits is excluded from the employee’s income by specific statutory provisions but the corporation is entitled to deduct the cost.
Two major questions related to this subject are:
- What are fringe benefits?
- How do partnerships treat fringe benefits?
There is no inclusive definition of “employee fringe benefit” for partnership. Subchapter K of the Internal Revenue Code, dealing with the tax treatment of partners and partnerships, contains no direct reference to “employee fringe benefits.” The general rule is that partners do not qualify for the exclusions afforded certain employee fringe benefits due to the absence of an employer-employee relationship. Absent an official definition of a fringe benefit in the partnership provisions, other sections of the Code must be examined to arrive at a definition of “employee fringe benefits.” Such an examination reveals that although there is no statutory definition, the legislative history of Code Sec. 1372 does list five employee benefits that
Congress considers to be fringe benefits.
- The former $5,000 death benefit exclusion set forth in former Code Sec. 101(b).
- The exclusion from income of amounts received by the taxpayer from an accident and health plan as set forth in Code Sec. 105(b), (c) and (d). 191
- The exclusion from income of amounts paid by an employer to an accident and health plan as provided in Code Sec. 106.
- The exclusion of the cost of up to $50,000 in group term life insurance on an employee’s life provided by Code Sec. 79. 192
- The exclusion from income of meals or lodging furnished for the convenience of the employer set forth in Code Sec. 119.
Tax-Free Fringes
When the fringe benefits listed are provided by the partnership or LLC to a partner or member in exchange for services, the benefits qualify for tax-favored treatment. This means the company can deduct the costs of providing these benefits and they are tax free to the recipient for federal income tax purposes. These employee benefits include:
- Group legal services plans.
- Pension and profit-sharing plans (Sec. 401(c)(1));
- Compensation for injury or sickness (Sec. 104(a)(3));
- Employer-provided educational assistance (sec. 127). The partnership can pay job-related education expenses for the partner and deduct the cost without the partner recognizing income; this is slightly different from educational assistance programs (which can be used for job-related or unrelated education)
- Child and dependent care assistance (sec 129) . (Provided that no more than 25% of the amounts paid annually are paid to 5% owners of the partnership)
- No-additional-cost services.
- Qualified employee discounts.
- Working conditions fringe benefits.
- De minimis fringe benefits.
- On-premises athletic facilities.
- Qualified retirement plans.
Fringes Treated as Taxable Guaranteed Payments
The cost of providing the following fringes to a partner or LLC member in exchange for services are treated as deductible guaranteed payments made by the entity and taxable income from guaranteed payments under Code Sec. 707(c).
- Group term life insurance coverage of up to $50,000 (Sec. 79);.
- Amounts received from accident and health plans (Sec. 105);
- Contributions by an employer to accident and health plans (Sec. 106);
- Premiums for accident and health insurance coverage for the partners and members, their spouses, and dependents.
- Meals and lodging furnished for the convenience of the employer (Sec. 119);
- Employee achievement awards (Sec. 74(c)
- Cafeteria plans (Sec. 125; Prop. Regs. Sec. 1.125-1(g)(2));
- Qualified transportation fringe benefits (Sec. 132(f));
- Adoption assistance programs (Sec. 137(c)(2));
- Contributions by the corporation to health savings accounts (Sec. 223); and
- Qualified moving expense reimbursements (Sec. 132(g)).
Each partner or LLC member can generally deduct 100 percent of his or her company-paid health insurance premiums on page 1 of Form 1040. (Sources: IRS Revenue Ruling 91-26 and IRC Section 162(l) However, the partner or LLC member is not entitled to any personal deductions for the other company-paid fringes listed above.
Sec. 1372(a) states that for fringe benefit purposes, an S corporation “shall be treated as a partnership” and a 2% shareholder “shall be treated as a partner of such partnership.” A 2% shareholder is one that owns more than 2% of the corporation’s outstanding stock on any day during the S corporation’s tax year, considering direct and constructive ownership (Secs. 1372(a) and (b)).