To tax or not to tax? Understanding employee discounts

October 23, 2018|Brad Wiedenhaft

Being aware of limits and eligibility requirements for employee discounts can ensure you are providing a benefit that actually benefits all involved.

Fringe benefits—a form of payment for the performance of work or services that is not straight salary—can be a nice perk for recruiting and retaining quality employees. A good example of a fringe benefit is giving an employee use of a company car.

Most fringe benefits are considered part of your employee’s pay and must be reported as taxable income at year-end. However, some exclusions apply, such as employee discounts.

Determining whether a discount or benefit is considered taxable income can be complicated. You can find a full explanation of the IRS rules on taxing fringe benefits here, but the following information is a good guide to get you started.

Exclusion for employee discounts

One of the most common exclusions from taxing fringe benefits is for a price reduction given to employees on property or services in the ordinary course of the line of business in which an employee performs substantial services, commonly known as an employee discount. This exclusion does NOT apply to real property or discounts on personal property of a kind commonly held for investments. Examples are stocks and bonds.

Eligibility

Employees eligible for this employee discount exclusion from taxable income include:

  • Current employees
  • Former employees who retired or left on disability
  • Widow or widower of an employee who retired or left on disability
  • Widow or widower of an employee who died while an employee
  • A leased employee who worked for you on a substantially full-time basis for at least a year if the services are performed primarily under your direction
  • A partner who performs services for a partnership

In addition, an employee’s spouse and dependent children can be treated the same as an employee for eligibility purposes. A dependent child includes any of the following:

  • Son, stepson, daughter, stepdaughter, or eligible foster child who is a dependent of employee
  • If both parents died and one of the above has not reached the age of 25
  • In the case of divorced parents, the child is a dependent of both parents

Limits

According to the IRS, you can generally exclude the value of an employee discount from the employee’s wages up to the following limits:

  • Discount on services: 20% of the price you charge nonemployee customers for that service
  • Discounts on merchandise or other property: your gross profit percentage multiplied by the price you charge nonemployees for the property

Note that there are some additional limits and exceptions to this rule for highly compensated employees, defined as an employee who received more than $120,000 in pay the preceding year or who owned at least 5% of the business at any point during the current or preceding year.

Examples

Let’s look at some examples to help clarify the rules.

Example #1: Discount on merchandise

John, an employee, purchased a jacket that had a sticker price of $100 using his employee discount. The company’s gross profit percentage is 34%. John received a 15% discount on the jacket, which would be excluded from income since it is less than the $34 gross profit percentage. If the company gave John a 50% discount, only 34% would be excluded, and the other 16% would be included as taxable compensation.

Example #2: Discount on service

William is an employee of a Quick Lube and receives a 10% discount on services. His oil change costs $50. The $5 discount he receives is excluded from wages since it is under the 20% threshold. If William received a 40% discount on his oil change, 20% (or $10) would need to be included as taxable compensation.

Employee discounts and other fringe benefits are an excellent way to create loyalty and goodwill among employees. Schenck can help you navigate the tax rules regarding employee discounts to ensure this fringe benefit actually benefits all involved.

If you have any questions about how to report or tax employee discounts, call your tax professional or contact us for more information.


Brad Wiedenhaft is a senior associate accountant at Schenck and member of the firm’s Hospitality & Retail team.



Tags: Payroll, Tax