Employer-Provided Tax Preparation Not a Working-Condition Fringe

In FSA 200137039, the IRS National Office ruled that tax preparation services provided to an employee as a condition of employment were not working-condition fringe benefits that he could exclude from income under Sec. 132. Rather, the professional services were taxable income to the employee for both income and employment tax purposes.

A company sent employees to work overseas. To ensure that the employees were fairly compensated for accepting this assignment, the company engaged an outside public accounting firm to prepare their income tax returns, and calculated the cost equalization of income taxes, housing and other personal living expenses. The company required the employees to use the public accounting firm. The firm charged the employees only for professional tax services for issues not related to their employment.

The company position was that the provision of tax preparation services was an excludible working-condition fringe, citing Rev. Rul. 92-69, under which outplacement services were found to qualify under Sec. 132. In that ruling, the Service noted that, for exclusion under Regs. Sec. 1.132-5(a)(2)(i):

(1) the employer derives a substantial business benefit from the provision of the property or services that is distinct from the benefit that it would derive from the mere payment of additional compensation, and (2) the employee's hypothetical payment for the property or services would otherwise be allowable as a deduction by the employee under section 162.

In FSA 200137039, the IRS ruled that employer-provided tax preparation services failed both of the tests; the company did not have to pay for the employees' income tax preparation to be able to calculate the cost-equalization adjustment. The company could simply obtain copies of their returns to make the calculations. Nevertheless, the Service acknowledged that only the adjustment calculation was an excludible working-condition fringe.

After finding that the payment constituted compensation for both income and employment tax purposes, the FSA defined the income amount as the amount that an employee would have paid the same accounting firm for the same services in an arm's-length transaction. This finding is interesting because:

• It is quite likely that the employee would not have otherwise needed a firm with that level of international tax expertise to prepare his return. However, the FSA stipulated that the income was determined as the amount the firm in question would have charged.
• A company with many expatriate employees may have negotiated a set per-employee fee for the international tax work. Because the employee's income amount was determined on the arm's-length value, it could be higher than the cost actually incurred by the employer.

In discussing the tax withholding requirements, FSA 200137039 states that the income might not be subject to income tax withholding if, at the time of payment, it was reasonable for the employer to believe that the income would be excluded from taxable income under the Sec. 911 foreign-earned-income exclusion. However, for FICA and FUTA purposes, no equivalent exclusion is available.

It would seem that the conclusions reached in FSA 200137039 are not affected by the Economic Growth and Tax Relief Reconciliation Act of 2001, which provides that employer-provided retirement planning services are excluded from an employee's income after 2001. The Committee Reports state: "the exclusion does not apply to services that may be related to retirement planning, such as tax preparation, accounting, legal or brokerage services."

From R. Milton Howell, III, Tax Manager, Davenport, Marvin, Joyce & Co., LLP, Greensboro, NC