Both the House and Senate versions of tax reform propose significant changes that may reduce or eliminate the tax benefits of many popular employer-provided fringe benefits, such as dependent care assistance programs, on-premises gyms and bicycle commuting expense reimbursements. In addition, many common deductions for work-related activities—including certain meal and entertainment expenses—may see sweeping changes.
In an effort to offset the revenue loss associated with proposed tax cuts, both the House tax reform bill (House Bill) and the corresponding Senate draft (Senate Bill) take aim at the tax treatment of several popular employer-provided fringe benefits. Tax reform may affect fringe benefit programs in two ways: repeal of exclusion from income for certain statutory benefits, and denial of an employer tax deduction for many fringe benefits.
At this early stage of the legislative process, it is important to note that these proposals are subject to change. The House and Senate disagree on many of the changes to employer-sponsored fringe benefits, and it is not clear which, if any, fringe benefits will be affected by the final bill. Nevertheless, it is important for employers to know which of their programs may be cut or eliminated as soon as 2018.
Educational Assistance Programs
Educational assistance programs allow employers to reimburse certain education-related expenses on a tax-free basis, up to a maximum of $5,250. As part of the consolidation and amendment of education-related tax benefits, the House Bill repeals education assistance programs under Section 127 of the Internal Revenue Code (Code), effective as of January 1, 2018. The Senate Bill does not affect current education assistance programs at all.
Even if education assistance program benefits are repealed, an employer may still reimburse qualifying educational benefits related to the employer’s business on a tax-free basis pursuant to Code Section 132(d). However, Code Section 132(d) contains numerous important restrictions on the type of expenses that can be excluded from the employee’s income. For example, Code Section 132(d) does not apply if the expenses would qualify the employee for a new career. As another alternative, an employer may continue to provide certain scholarship benefits under Code Section 117.
Dependent Care Assistance Programs
Dependent care assistance programs (DCAPs) allow employees to put aside up to $5,000 per year in pre-tax contributions to pay for certain qualifying expenses related to dependent care incurred during that year. The first House proposal eliminated the favorable tax treatment for DCAP exclusions effective as of January 1, 2018. However, subsequent amendments to the House Bill have postponed the elimination of DCAPs until at least 2023. The Senate, on the other hand, has not proposed any changes to the tax treatment of DCAPs.
The Code’s dependent care credit can provide a similar tax benefit to a DCAP. Because the House Bill retains the dependent care credit, the effect of repealing DCAPs will make a difference only to those employees for whom the $5,000 DCAP exclusion from tax is more beneficial than the dependent care credit.
Qualified Moving Expense Reimbursements
The House Bill and the Senate Bill discontinue the favorable tax treatment for employer reimbursements of an employee’s moving expenses effective as of January 1, 2018. Only a few types of expenses currently qualify for this exclusion: the cost of moving household goods and personal effects from a former residence to a new residence, and the cost of travel, including lodging, from the former residence to the new place of residence for members of the household.
In addition, both the House and Senate Bills repeal the deduction of moving expenses that are not paid or reimbursed by an employer. This means that no tax benefits will be available with respect to an employee’s move for work, regardless of whether the employer or employee bears the cost. Under the latest Senate Bill, the favorable tax treatment for moving expenses would revert to its pre-2018 form beginning in 2026.
Employee Achievement Awards
Code Sections 132 and 274(j) allow employers to provide different types of employee achievement awards on a tax-free basis. This exclusion applies to the value of any tangible personal property given to an employee as an award for either length of service or safety achievement—e.g., the traditional “gold watch” award for service. The exclusion does not apply to awards of cash, cash equivalents, gift certificates or other intangible property such as vacations, meals, lodging, tickets to theater or sporting events, stocks, bonds and other securities. The amount of the exclusion is $1,600 ($400 for awards that are not “qualified plan awards”) per employee annually. The House Bill would repeal this tax-free benefit effective as of January 1, 2018. The Senate Bill does not address employee achievement awards.
Employee achievement awards are a popular tax-free benefit to recognize employee performance. If the House Bill passes, employers may wish to provide more de minimis in-kind benefits to recognize employees’ performance; however, such benefits must be very low in value to qualify for this exclusion.
Adoption Assistance Programs
Code Section 137 provides favorable tax treatment for employer reimbursements of certain adoption expenses. The House Bill would repeal Section 137 effective as of January 1, 2018; the Senate Bill does not affect Section 137.
Code Section 119 excludes the value of lodging furnished to an employee, spouse or dependent by or on behalf of an employer. The exclusion is available only where the lodging is provided for the convenience of the employer and where the employee is required to accept the lodging as a condition of employment.
The House Bill limits this exclusion to $50,000 ($25,000 in the case of a married individual filing a separate return), subject to a phase-out based on the employee’s level of compensation. The House’s proposed limitation goes into effect January 1, 2018. The Senate Bill does not include any changes to Code Section 119.
Bicycle Commuting Expense Reimbursements
Code Section 132 allows employers to reimburse certain eligible bicycle commuting expenses on a tax-free basis. The House Bill excludes all transportation expenses, including bicycle commuting. The Senate Bill specifically repeals the bicycle commuting expense exclusion effective as of January 1, 2018.
Employer-Provided Childcare Credit
Currently, Code Section 45(f) allows employers to claim a credit of up to $150,000, equal to 25 percent of qualified expenses for employer-provided childcare and 10 percent of qualified expenses for childcare resource and referral services. The House Bill would repeal the employer-provided childcare credit. The Senate Bill does not address this provision.
Other Employee Fringe Benefits, Including Meals and Entertainment
Code Section 274 governs the tax treatment of work-related entertainment expenses, which include meals, club dues, amusement and other recreation expenses. Generally speaking, the current House Bill and Senate Bill completely eliminate the employer tax deduction for substantially all directly paid or reimbursed business entertainment expenses, but allow employers to deduct up to 50 percent of certain enumerated expenses, such as non-entertainment client dinners.
The House Bill amends the complex rules of Code Section 274 by broadly eliminating the deduction for all entertainment and recreation expenses, even if the expenses have a connection to the taxpayer’s business. The House Bill appears to have the following results:
Typical business entertainment (e.g., taking the client out for the evening after a business meeting) would be 100 percent non-deductible, instead of 50 percent deductible under the current rule.
Business travel meals that are not “entertainment” would remain subject to the existing 50 percent disallowance. This means that taxpayers will need to carefully review all expenses to determine whether they are business entertainment expenses or business travel expenses.
Holiday parties, picnics and other entertainment activity expenses for employees generally would be 100 percent non-deductible, with an exception for food and beverages provided on the premises of the employer.
Expenses related to athletic facilities, club memberships and personal amenities not related to the employer’s trade or business would also be 100 percent disallowed (unless one of the few exceptions applies).
Qualified transportation fringes, such as commuting benefits and tax-free employee parking, would also be non-deductible.
Favorably, non-meal entertainment expenses associated with certain employee meetings, stockholder meetings and meetings of business leagues would be 100 percent deductible. The related meal expenses would be subject to the 50 percent business meals disallowance, unless the de minimis exception applies.
The Senate Bill also amends Code Section 274. Unlike the House Bill, the Senate Bill seemingly retains more elements of the current Section 274 deduction. Under the Senate’s proposed rewrite of Code Section 274:
Typical business entertainment would be 100 percent non-deductible.
The 50 percent deduction for business-related food and beverage expenses would be expanded to include food and beverages provided to employees through an eating facility that meets the requirements for de minimis fringe benefits.
The deduction for expenses associated with providing any qualified transportation fringe benefit, including for commuting between the employee’s residence and place of employment, would be disallowed, except as necessary for ensuring the safety of the employee.
Employers should expect to see significant changes to the tax reform bills as they make their way through the legislative process. Given the substantial differences between the House and the Senate’s approach towards fringe benefit taxation, it is unclear whether employers will be required to make changes to their programs at this time. Nevertheless, because these bills may affect common fringe benefit programs as soon as 2018, employers should keep a close eye on the developing legislation.
McDermott’s tax reform task force is monitoring legislative developments closely. If you have any questions regarding the implications of the proposed tax reform on your employee benefits programs, please reach out to your regular McDermott lawyer or one of the authors.