This topic is a recent addition to this Technical Index. Accordingly, more information will be added in the weeks ahead.
Fringe benefits are often taxable to the employee if they are substantial in value. However, this is not always the result. Read below about a recent case where an employer-paid annual employee fishing trip to a 5-star resort was deemed to be non-taxable.
Annual employee trips to a five-star resort in Canada…a deductible business expense? Many people would say no. The Court of Appeals for the Eighth Circuit recently said yes. It overruled a district court and held that employees did not have to include the costs of the annual trips in their incomes. The decision in Townsend v. Commr, CA-8, Sept. 15, 2003, illustrates the extremely subjective nature of working condition fringe benefits. The district court ruled that the costs of the trips constituted wages to the employees. The appellate court, looking at the same facts, concluded just the opposite.
Who’s an employee?
Many employers offer fringe benefits. Some offer more than others, but pretty much every employer offers something. Whether it is use of the office copy machine, paid parking, meals, or other benefits, they, unlike cash compensation, are usually not taxable to the employee.
First, the benefit must be given to an employee. The definition is larger than just someone who receives wages. For purposes of a working condition fringe benefit, an employee includes:
- Individuals receiving wages;
- Directors and officers; and
- Independent contractors.
- Comment. Working condition fringe benefits may be provided to employees but not to spouses or dependents.
The rule about working condition fringe benefits appears straightforward. They are excluded from the recipient’s gross income. However, what constitutes a working condition fringe benefit is often quite murky.
By the way, don’t automatically equate working condition fringe benefits with de minimis benefits. If the value of a working condition fringe benefit is so small that accounting for it would be administratively impractical, it may be excluded from the employee’s income as a de minimis benefit. However, not all working condition fringe benefits are so small in value. The four day fishing trip in Townsend cost substantial dollars.
Ordinary and necessary
A working condition fringe benefit must be deductible as an ordinary and necessary business expense. They are benefits the employee would have been entitled to deduct had he or she paid for them. As the district court in Townsend noted, although the terms ordinary and necessary have been repeatedly construed and applied, no definite standard has been formulated for determining if a claimed deduction qualifies as an ordinary and necessary expense in a taxpayer’s particular business.
Business expenses are generally tested by their reasonableness and soundness in light of the taxpayer’s business. Ultimately, it is a question of fact.
This case illustrates the importance of credible testimony to paint the facts in the light most attractive to the taxpayer. The appellate court reviewed the testimony of the taxpayer’s employees very carefully. Their testimony painted a vivid picture of what went on during the annual fishing trips. They testified in detail about product development, informal meetings between salespeople, head office staff and factory workers, and other business activities. They did not portray the trips as vacations even though they were held at a resort.
Some common benefits
Benefits that have been held to be working condition fringe benefits include:
- Outplacement services;
- Personal use of corporate-owned vehicles;
- Use of corporate products for product-testing purposes;
- Employer-provided education assistance (to the extent it is not excluded under an educational assistance program);
- Professional dues; and
- Subscriptions to business periodicals.
Business first; social activities second
The Eighth Circuit warned taxpayers that its decision should be applied across-the-board in every case where an employer sponsors trips to luxury vacation spots. It predicted that the costs of most trips would be taxable to employees. It cautioned district courts to be suspicious of oral, non-contemporaneous evidence. That said, it still found for the employer.
In this case, both courts noted favorably the employer’s “me too” business philosophy. The district court even went so far as to state that the taxpayer was an exemplary employer who genuinely cared about its employees and added that the company’s success for more than 40 years reflected the legitimacy of its workplace philosophy. The appellate court also noted that the taxpayer was a company that “loved surprises.”
What can be gleaned from Townsend? Employees should be required to go, or at least strongly encouraged, and most of the discussions during the trip must be about business.
The employer in Townsend did not require employees to go on the fishing trips but it did strongly encourage them to go. The owner testified, “we do lean on them (employees).” The CEO testified he visited employees and told them about the trips. Faced with such strong encouragement, employees went on the trips even if they didn’t like fishing and they went year after year. Employees testified that they felt it was their “duty” to go on the trips.
While at the resort, they talked shop. Managers and employees discussed new product ideas and competitive pressures. One employee characterized the amount of discussion about new products as “tremendous.” Employees also discussed problems that customers encountered and company responses. Other topics included quality control, sales tactics and issues related to big customers. Even while fishing, business took the front seat.
It helped the employer that spouses and children stayed home. When non-employees are present and the venue is social, such as attending a sporting event, it’s much easier to characterize the trip as a group social excursion or paid vacation with business being secondary.