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Employee Fringe Benefits: § 132

30 July, 2015 - 12:08

Prior to 1984 – and as taxpayer Kowalski argued – there evolved an uneven patchwork of “fringe benefits” that employers and employees alike assumed were not subject to income tax. This cost the Treasury revenue and resulted in horizontal inequities. Congress addressed the problem, and in 1984, “drew a line in the sand.” The following is an explanation of what Congress did and why.

H. Rep. No. 98-432 (II), 98th Cong., 2d Sess. 1984, at 412, 1984 U.S.C.C.A.N. 697, 1215, 1984 WL 37400, to accompany H.R. 4170.


In providing statutory rules for exclusion of certain fringe benefits for income and payroll tax purposes, the committee has attempted to strike a balance between two competing objectives.

First, the committee is aware that in many industries, employees may receive, either free or at a discount, goods and services which the employer sells to the general public. In many cases, these practices are long established, and have been treated by employers, employees, and the IRS as not giving rise to taxable income. Although employees may receive an economic benefit from the availability of these free or discounted goods or services, employers often have valid business reasons, other than simply providing compensation, for encouraging employees to avail themselves of the products which they sell to the public. For example, a retail clothing business will want its salespersons to wear, when they deal with customers, the clothing which it seeks to sell to the public. In addition, the fact that the selection of goods and services usually available from a particular employer usually is restricted makes it appropriate to provide a limited exclusion, when such discounts are generally made available to employees, for the income employees realize from obtaining free or reduced-cost goods or services. The committee believes, therefore, that many present practices under which employers may provide to a broad group of employees, either free or at a discount, the products and services which the employer sells or provides to the public do not serve merely to replace cash compensation. These reasons support the committee’s decision to codify the ability of employers to continue these practices without imposition of income or payroll taxes.

The second objective of the committee’s bill is to set forth clear boundaries for the provision of tax-free benefits. ... [A]dministrators of the tax law have not had clear guidelines in this area, and hence taxpayers in identical situations have been treated differently. The inequities, confusion, and administrative difficulties for businesses, employees, and the IRS ... have increased substantially in recent years. The committee believes that it is unacceptable to allow these conditions ... to continue any longer.

In addition, the committee is concerned that without any well-defined limits on the ability of employers to compensate their employees tax-free by using a medium other than cash, new practices will emerge that could shrink the income tax base significantly, and further shift a disproportionate tax burden to those individuals whose compensation is in the form of cash. A shrinkage of the base of the social security payroll tax could also pose a threat to the viability of the social security system above and beyond the adverse projections which the congress recently addressed in the social security amendments of 1983. Finally, an unrestrained expansion of noncash compensation would increase inequities among employees in different types of businesses, and among employers as well.

The nondiscrimination rule is an important common thread among the types of fringe benefits which are excluded under the bill from income and employment taxes. Under the bill, most fringe benefits may be made available tax-free to officers, owners, or highly compensated employees only if the benefits are also provided on substantially equal terms to other employees. The committee believes that it would be fundamentally unfair to provide tax-free treatment for economic benefits that are furnished only to highly paid executives. Further, where benefits are limited to the highly paid, it is more likely that the benefit is being provided so that those who control the business can receive compensation in a nontaxable form; in that situation, the reasons stated above for allowing tax-free treatment would not be applicable. Also, if highly paid executives could receive free from taxation economic benefits that are denied to lower-paid employees, while the latter are compensated only in fully taxable cash, the committee is concerned that this situation would exacerbate problems of noncompliance among taxpayers. In this regard, some commentators argue that the current situation – in which the lack of clear rules for the tax treatment of nonstatutory fringe benefits encourages the nonreporting of many types of compensatory benefits – has led to nonreporting of types of cash income which are clearly taxable under present-law rules, such as interest and dividends.

In summary, the committee believes that by providing rules which essentially codify many present practices under which employers provide their own products and services tax-free to a broad group of employees ... the bill substantially improves the equity and administration of the tax system.

C. Explanation of Provisions

1. Overview

Under the bill, certain fringe benefits provided by an employer are excluded from the recipient employee’s gross income for federal income tax purposes and from the wage base (and, if applicable, the benefit base) for purposes of income tax withholding, FICA, FUTA, and RRTA.


Any fringe benefit that does not qualify for exclusion under the bill (for example, free or discounted goods or services which are limited to corporate officers) and that is not excluded under another statutory fringe benefit provision of the code is taxable to the recipient under ... §§ 61 and 83, and is includible in wages for employment tax purposes, at the excess of its fair market value over any amount paid by the employee for the benefit.

Notes and Questions:

1. As the Report implies, the notion that fringe benefits were nontaxable had gotten out of hand. The approach of Congress was to define fringe benefits that are excludible from gross income and to draw a line in the sand: “this far and no farther.”

2. Read § 132. Consider these problems:

1. Phillip works for Sports World, a mega-sporting goods store. Phillip enjoys being outdoors and so would probably spend a lot of time shopping at Sports World, even if he didn’t work there. Last year, Sports World sold $10M worth of sporting goods. The cost of its merchandise was $7M, but its overhead was $2M. Sports World offers its employees a 25% employee discount on items that employees purchase. Phillip purchased a fishing boat that retails for $1000. Phillip paid $750.

  • Tax consequences to Phillip?

1a. One week later, Phillip sold the fishing boat to his brother for $1050.

  • Tax consequences to Phillip?
  • See § 132(a)(2) and § 132(c).

1b. Sports World is located in a large building whose tenants once included a professional basketball team and a perennial NCAA basketball power. The oddly-shaped building stood empty for several years. Service merchants in the area (restaurants, dry cleaners, dentists, optometrists, etc.) were anxious that Sports World would occupy the building and readily entered into reciprocal arrangements whereby employees of Sports World were entitled to a 20% discount off the retail prices of these merchants’ services. Sports World agreed to give only a 10% discount for the employees of these service merchants. Last week, Phillip paid $80 for dental services that normally cost $100. A nearby optometrist purchased a tent from Sports World that normally retails for $100 for only $90.

  • Tax consequences to Phillip?
  • Tax consequences to the optometrist?
  • See § 132(i).

2. Mesquite Airlines is a commercial airline. It offers its employees free standby air travel. Moreover, Mesquite Airlines has entered into a reciprocal agreement with several other airlines whereby employees of Mesquite may fly standby for free on other airlines, and employees of the other airlines may fly free on Mesquite Airlines. Megan is a retired airline pilot who flew airplanes for Mesquite Airlines for 35 years. Megan flew standby on a Mesquite Airlines flight; the normal fare was $400.

  • Tax consequences to Megan? See § 132(h).

2a. Megan flew standby on another airline. The normal fare was $400.

  • Tax consequences to Megan?

2b. Without charging her, Mesquite Airlines permitted Megan to reserve her seat for two weeks from now. The normal fare was $400.

  • Tax consequences to Megan?

3. The University of Memphis recently moved into a new building in downtown Memphis. The faculty members chose their offices pursuant to a system that incorporated consideration of rank and seniority. Staff offices have a rental value of $3600 per year. Professor K now has a corner office with a nice view of the Mississippi River. The rental value of the “worst” faculty office is $4800 per year. The rental value of Professor K’s office is $14,400 per year.

  • Tax consequences to Professor K? See § 132(a)(3) and § 132(d).

Codes and Regulations

By now you should have gained some facility flipping between the provisions of the Code and the Regulations. Within that context, this reminder might be appropriate. The Code is the text that Congress enacted. It is law so long as it is consistent with the Constitution. The Regulations are text that the Treasury Department adopted to construe the Code. It also is law, so long as it is consistent with the Code and the Constitution. You have already seen implementation of this hierarchy in cases that you have read.

3a. Same facts. The Law School purchased for Professor K and one other professor (but no one else) online access to the CCH Federal Tax Reporter. The retail cost of this access is $2500 per year.

  • Tax consequences to Professor K?
    • Is there any other information you need to answer this question?

4. Joe the Plumber, Inc. sells plumbing services to customers. It has a policy of offering employees a 25% discount on plumbing services that they purchase from Joe the Plumber, Inc. However, Joe the Plumber, Inc. offers a 40% discount to its “highly-compensated” employees. An employee purchased plumbing services that normally cost $200 for $150. One of Joe the Plumber’s highly-compensated employees purchased the same services for $120.

  • Tax consequences to the employee?
  • Tax consequences to the highly-compensated employee?
  • See § 132(j)(1).

5. Lotsa Refunds, Inc. is a tax return preparer that does a volume business among unbanked, low-income persons. The corporation has ten employees. At the end of a very hectic tax season, Lotsa Refunds presented each of its employees with a $50 prepaid Mastercard cash card, in addition to their normal wages. This was because of the gratitude Lotsa Refunds felt for its employees having worked long hours against tight deadlines. Lotsa Refunds’ highly-compensated employees did not receive such a card.

  • Tax consequences to the employees?

5a. The employees of Lotsa Refunds, Inc. worked from 7 a.m. until 12 midnight every night between April 1 and April 15. Because of the fact that criminal activity increases after midnight, Lotsa Refunds paid cab-fare to all of its employees on those days – both from and to work in the morning. Assume that a typical cab fare is $15.

  • Tax consequences to the employees? See Reg. § 1.132-6(d)(2)(iii)(A, B, and C).
    • Are there any more facts you might wish to know?

6. Springfield Memorial Hospital operates a cafeteria for its workers. Its prices for each food item cover the direct operating costs of selling that item. This price is less than the fmv of the item if it were sold in a for-profit cafeteria. Some of its workers are on call for emergencies at all times, even during their mealtimes. The mealtimes of these workers is 30 minutes. These employees have special passes in the cafeteria which permit them to take food equal to $7 “worth” of food. Other personnel may eat in the cafeteria, but must pay the charge listed for each food item; these persons are not on call, and many of them do not eat in the cafeteria. Overall, the cafeteria loses money because most employees in the first group do eat in the cafeteria.

  • Tax consequences to the first group of employees?
  • Tax consequences to the second group of employees?
  • See § 132(e)(2), including carryout paragraph.

7. Taxpayer Wheeler lives five miles from his place of employment. Every day, he rides his Pistoldale Black Shadow bicycle that he bought several years ago and has used ever since for exercise and enjoyment. He also uses his bicycle every summer for a bicycle tour, and these tours are usually between 1000 and 1500 miles in length. He usually rides about sixty miles per weekend with a bicycle club. During the calendar year, Wheeler purchased new pedals for his bicycle to replace the ones he had that were ten years old (price: $120), a new chain which must be replaced every year (price: $10), tire tubes (4 @ $6/tube, total $24), and a new headlight because he did not have one (price: $30). Wheeler did not receive from his employer transportation in a commuter highway vehicle, a transit pass, or a parking place near his employer’s office. At the end of the year, Wheeler presented his receipts for the above items to his employer who reimbursed him $174 in cash. How much of this reimbursement must Wheeler include in his gross income?

8. Read §§ 82, 132(a)(6), 132(g), 217. Moving expenses are excluded from gross income only in certain circumstances. What are they? How does the Code provide for horizontal equity among taxpayers, some of whose employers pay their moving expenses and some of whose employers do not pay such expenses. We take up the Code provisions governing moving expenses in more detail in chapter 7-III-A.


Do (again) CALI Lesson, Basic Federal Income Taxation: Gross Income: The Taxability of Employment Connected Payments: Fringe Benefits, Meals and Lodging, Unemployment Compensation, and Social Security Benefits.