September 25, 2012

Tax-Free Fringe Benefits for Pass-Through Owners

Partnerships, limited liability companies (“LLCs”) treated as partnerships, and S corporations have distinct tax and nontax advantages. However, entrepreneurs considering these forms of businesses should be aware that fewer tax-free and tax-favored fringe benefits are available to owner-entrepreneurs of pass throughs than to shareholder-employees of C corporations.

Statutory rules allowing or denying fringe benefits to pass-through owners are stated explicitly only in the context of partners and partnerships. However, under the default classification rules, a domestic-eligible entity with two or more members automatically is treated as a partnership unless it elects to be taxed as an association (i.e., as a corporation). For fringe benefit purposes, more-than-2% S corporation shareholder-employees are subject to the rules that apply to partners, and S corporations are treated as partnerships. As a result, unless otherwise noted, the tax consequences of fringe benefits for members of LLCs taxed as partnerships and for more-than-2% S corporation shareholder-employees are the same as they are for partners.

Working condition fringe benefits. Property or services supplied by an employer to an employee are tax-free working condition fringe benefits (“WCFBs”) if the employee would be entitled to a business expense deduction for the item if he or she had paid for it. Partners may receive the following WCFBs tax-free:

  • Business-related use of a company auto, if properly substantiated. The personal-use value of the auto must, however, be treated as compensation income.
  • The business-use portion of company-paid country club dues, even though the dues are completely nondeductible.
  • Job-related education expenses paid by the firm.
  • Job placement assistance.
  • The use of a cell phone provided to an employee primarily for noncompensatory business reasons.

De minimis fringe benefits. For purposes of the tax-free de minimis fringe benefit rules, “employees” include any recipient of a fringe benefit. Partners are entitled to tax-free meals or meal money and local transportation fare, if it is provided on an occasional basis in connection with overtime work. Other de minimis fringe benefits include:

  • Traditional birthday or holiday gifts of property (not cash) with a low fair market value, occasional theater or sporting event tickets, fruit, books, or similar property provided under special circumstances (e.g., for illness, outstanding performance, or family crisis).
  • Traditional awards, such as a gold watch, upon retirement after lengthy service.
  • Personal use of a cell phone provided primarily for noncompensatory business reasons.

Dependent care assistance. Partners are eligible for the Code Sec. 129 dependent care assistance exclusion. The exclusion is for amounts provided under a written plan of the employer and is limited annually to $5,000 ($2,500 for a married person filing separately). However, for a plan to qualify as a dependent care assistance program, no more than 25% of the amount paid or incurred by the employer for dependent care assistance during the year may be provided for the class of individuals who are shareholders or owners and their spouses or dependents, each of whom (on any day of the year) owns more than 5% of the stock or of the capital or profit interest in the employer.

Educational assistance programs.Employers can establish educational assistance programs under which employees can receive up to $5,250 per year of graduate or undergraduate-level educational assistance tax-free, whether or not job related. For this purpose, employees include partners who have earned income from their partnerships which, in turn, are treated as employers of these partners. However, no more than 5% of the cost of annual benefits may be provided for the class of individuals (and their spouses and dependents) each of whom (on any day of the year) own more than 5% of the stock or of the capital or profits interest in the employer.  The exclusion for employer-provided educational assistance expires after December 31, 2012.

Athletic facilities. The exclusion for on-premises athletic facilities (e.g., swimming pool, gym, etc.) is available to partners and their spouses and/or children.

No-additional-cost services and qualified employee discounts.For purposes of these tax-free fringe benefits, partners who perform services for a partnership are treated as employed by the partnership.

Transportation fringe benefits.Under the de minimis benefit rules, tokens or fare cards provided by a partnership to a partner that enable the recipient to commute on a public transit system, not including privately operated van pools, are excludable from income if the value of the tokens or fare cards in any month does not exceed $21. If the monthly value of a pass exceeds $21, the full value of the benefit is includible.

In addition, if a partner can deduct the cost of parking as a business expense, such as the parking cost incurred in connection with traveling from a regular office to another business office, the value of the free or reduced-cost parking is excludable as a working condition fringe benefit.

If you have any questions about the information above, please contact the expert listed below at PYA, (800) 270-9629.