May 20, 2009

EXTRA PAYMENTS TO EMPLOYEES | Nonretirement Benefits

Educational Assistance

For several years the Internal Revenue Code has provided favorable tax treatment to employees who receive benefits from their employers for educational assistance. Section 127 of the Code, which allows employees to receive annually the first $5,250 of these benefits on a tax-free basis, is scheduled to expire for courses beginning after December 31, 2001. (However, the date has been extended several times before and will probably be extended again, or the Code section may be made permanent.) For benefits to be tax free, the employer's plan cannot discriminate with respect to eligibility in favor of officers, shareholders, highly compensated employees, or their dependents. In addition, no more than 5 percent of the benefits may be paid out to shareholders or owners (or their dependents) who are more-than-5-percent owners of the firm.

Eligible benefits include tuition, fees, and books. The costs of supplies and equipment are also included as long as they are not retained after completion of the course. Meals, lodging, and transportation associated with educational expenses cannot be received tax free, nor can tax-free educational assistance be provided for graduate-level courses. For purposes of Sec. 127, a graduate-level course is defined as any course taken by an employee who has a bachelor's degree or is receiving credit toward a more advanced degree, if the particular course can be taken for credit by any individual in a program leading to a law, business, medical, or other advanced academic or professional degree. Courses involving sports, games, or hobbies are also ineligible for favorable tax treatment. Although an employer's plan can pay for any of these types of courses, an employee will be taxed on the value of the employer's contribution to their cost.

Many employers provide reimbursement for certain educational expenses that do not qualify for favorable tax treatment under Section 127. While such reimbursements result in taxable compensation for an employee, the employee may be eligible for a federal income tax deduction (subject to the 2-percent-of-adjusted-gross-income floor on miscellaneous itemized deductions) if he or she itemizes deductions. The deduction is allowed for educational expenses that are incurred (1) to maintain or improve a skill required in employment or (2) to meet the express requirements of the employer as a condition for retaining employment. Other types of educational expenses, such as costs incurred to qualify the employee for a new trade or business, are not deductible.

Moving-Expense Reimbursement

To attract new employees and to encourage current employees to move to suit the employer's needs, many businesses provide reimbursement for moving expenses. Such reimbursement is includable in an employee's income, but the employee is allowed certain offsetting income tax deductions if specified rules are satisfied. To receive the deductions, the employee must have moved because of a change in job location. In addition, the employee must satisfy both a distance test and a time test. The distance test requires that the employee's new workplace be at least 50 miles farther from the employee's old residence than the employee's old workplace (or at least 50 miles from the employee's old residence if the employee was previously unemployed). The time test requires that the employee work full-time in the general location of the new residence for at least 39 weeks during the 12 months following the move. An employee may take the applicable deductions in anticipation of satisfying the time test, but additional taxes will be payable if the time test is not ultimately met.

If all the preceding rules are satisfied, an employee may deduct the following expenses:

  • Transportation expenses in moving household goods and personal effects

  • Travel and lodging (but not meal) expenses in moving to the new residence

An employer may pay for other expenses, such as expenses to sell an old residence, premove travel to look for a new residence, or temporary living costs at the new location. Because these reimbursements will be taxable income without a corresponding deduction, the employer may give the employee a bonus to offset the increased tax.

Suggestion Awards

Some employers, particularly those in manufacturing industries, give awards to employees who make suggestions that will improve the operating efficiency of the firm if implemented. The awards are often a percentage of the firm's estimated savings over some specified future period of time but may be subject to a maximum dollar amount. If a suggestion plan is properly administered, the benefits of the plan may far exceed its costs while at the same time increasing the motivation and involvement of employees.

Suggestion awards are included in an employee's gross income for tax purposes.

Service Awards

Many employers provide awards to employees for length of service. These awards are often nominal for short periods of service (five or ten years) and may consist of such items as key chains, flowers, or pens. Awards typically increase in value for longer periods of service, and employees may actually be given some choice in the award received.

If the value of a service award is de minimis, it is not included in an employee's income. To be de minimis the value of the benefit must be so minimal that accounting for the cost of the benefit would be unreasonable or administratively impractical. Service awards of higher value may also be excludable from an employee's income if they are considered qualified plan awards. However, the total amount excludable from an employee's income for qualified plan awards (which also include awards for safety) cannot exceed $1,600 per year. Qualified plan awards must be provided under a permanent written program that does not discriminate in favor of officers, shareholders, or highly compensated employees. In addition, the average annual cost of all awards under the plan cannot exceed $400.

Productivity and Safety Achievement Awards

Some employers provide awards for productivity and safety achievement. Productivity awards are fully treated as compensation. However, while awards for safety achievement given to professional, administrative, managerial, or clerical employees are fully taxable, such awards are treated as qualified plan awards for other employees and are included in the $1,600 excludable figure mentioned previously under service awards.

Holiday Bonuses and Gifts

Many employers give gifts or bonuses to employees, particularly at Christmastime. Because the value of such gifts is typically small, some employees tend to resent gifts of money. Therefore, gifts such as liquor or a ham are often given.

As with service awards, a holiday gift does not result in taxation for an employee as long as the market value of the gift is small.


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