United States

Tax law revises the treatment of employee benefits

FINANCIAL REPORTING INSIGHTS  | 

The new federal tax law signed on December 22, 2017 (known as the Tax Cuts and Jobs Act) is a long and complex piece of legislation. The good news is that it included few changes to the rules governing qualified retirement plans. However, it did eliminate the tax-advantaged status of a number of fringe benefits. While “fringe benefits” can be a broad term with different contexts, it often is used to refer to certain employee benefits that qualify for an exclusion from the employee’s gross income even though they are payments made by the employer that would generally be a taxable payment for services. The result of these changes will be that certain benefits will become non-deductible payments by the employer or taxable wages to the employee or both.

The effective date of these changes is January 1, 2018. Where such benefits become taxable income, the employer must promptly revise its payroll system to report and withhold on such payments, which previously would have been excluded, if the employer continues to provide such benefits.

When revising payroll systems, employers also must consider the treatment of such amounts under their retirement plan, as all retirement plans have specific provisions defining what is considered “compensation” for purposes of calculating plan contributions and allocations. Some plans are designed to exclude taxable fringe benefits from the definition of compensation. In that case, no amendment might be needed where the exclusion of these additional benefits is consistent with that definition. Alternatively, the employer may need to amend the plan to exclude these elements of newly taxable compensation if it is not desirable to calculate retirement plan contributions on these amounts. In either case, the result may impact the nondiscrimination testing for the plan. Finally, the decision might be made to leave the plan as written and to change procedures to properly report this compensation under the plan.

The effective date of these changes leaves little time to revise payroll systems to address these matters.

The following table is intended to provide a high-level overview of the benefits that may be affected.

Benefit

Current provision

Revised provision

Consequence

Transportation benefits

Employers may generally deduct expenses for certain employer-provided fringe benefits, including qualified transportation fringe benefits.

Repeals deduction for any qualified transportation fringe benefit. Employers may not deduct any expense incurred in providing, paying or reimbursing employee commuting expenses except as necessary to ensure employee safety. If provided, the benefits remain tax-free to the employee, however.

Because this expense becomes non-deductible when paid directly by the employer, the employer’s choices are:

  • Continue the program as is and forego the deduction on the amount of benefit provided.
  • Discontinue the program and make direct cash payments to employees as additional wages to permit them to cover their transportation costs. (This alternative also may be seen as continuing to provide the benefit but including it in taxable wages.)
  • Discontinue the program without additional cash payments to cover the loss of benefit.
  • Some combination of the above.

 

Qualified moving expense reimbursements

Employees may exclude employer-provided moving expense reimbursements from gross income and wages for employment tax purposes.

Repeals exclusion for employer-provided qualified moving expense reimbursements, but provides an exception for members of the U.S. Armed Forces on active duty who move pursuant to a military order and incident to a permanent change of station.

This will require a change to the payroll system to reclassify these amounts as taxable wages subject to reporting on Form W-2 and income and payroll tax withholding. Thus consideration should be given to the definition of compensation within your plan for salary deferral and employer contribution purposes. Again, the employer has multiple choices for amending plan terms to address this or simply modifying the payroll system to make sure the reimbursements are properly coded for plan purposes.

Qualified bicycle commuting reimbursements

Qualified bicycle commuting reimbursements of up to $20 per month are excludible from an employee’s gross income.

Repeals income exclusion for qualified bicycle reimbursements.

This could be addressed in the same way as the qualified moving expense reimbursement.

Employee achievement awards

Employers may deduct the cost of employee achievement awards up to a certain amount. Such awards also are excludible from an employee’s gross income and wages for employment tax purposes. An employee achievement award is an item of tangible personal property given to an employee in recognition of either length of service or safety achievement and presented as part of a meaningful presentation.

Adds a definition of “tangible personal property” that may be considered a deductible employee achievement award, which clarifies that tangible personal property shall not include cash, cash equivalents, gift cards, gift coupons or gift certificates (other than arrangements conferring only the right to select and receive tangible personal property from a limited array of items pre-selected or pre-approved by the employer), vacations, meals, lodging, tickets to theater or sporting events, stocks, bonds, other securities and other similar items.

 

The employer must either redesign its program to comply with the limited definition of an excludable achievement award or modify its payroll system to recognize the awards as taxable income subject to income tax reporting and income and payroll tax withholding. Where the choice is made that triggers additional taxable income to the employee, the employer must consider how to handle it within the benefit plan, which may require a change in plan terms or just a change in the classification of the payment for plan purposes.

 

The first step in reacting to these changes is to consider whether these benefits are being provided and whether they will continue to be provided. Once that decision has been made, employers can then consider the impact to payroll reporting and retirement plan treatment. Correct reporting will require coordination between employers, payroll agencies, third-party administrators and the employer’s accountants in many cases.

It is also important to consider any state payroll implications resulting from the federal changes. While many states follow the federal rules on taxable income, some states have separate rules for what is considered taxable wages. For example, contributions to a 401(k) plan are taxable in Pennsylvania at the time of contribution rather than at the time of distribution as under federal rules. Employers will need to watch for states to react to federal changes with respect to these taxable fringe benefits as with many of the other areas of the new law.

See our additional summary of changes to healthcare and related employee benefits under the new law here.