De Minimis: lacking significance or importance : so minor as to merit disregard
—Merriam-Webster Dictionary
Taxable compensation and employee benefits are concepts that are deeply intertwined. There are some types of employee benefits that are not included in an employee’s taxable income, and other types which must be included. Qualified retirement plans determine contributions in relation to compensation, based upon a definition of taxable compensation or a variation thereof. Compensation reported in Box 1 of Form W-2 is a common base definition used in qualified retirement plans. Not to mention employment tax calculations. So, what goes into Box 1 of Form W-2 is important to get right.
This raises several questions, including—
- What if the compensation is a really small amount?
- What if it isn’t cash? How do deferrals get made from non-cash compensation?
What types of compensation are “so minor as to merit disregard”?
A detailed and practical description of de minimis compensation in the benefits context may be found in a memorandum issued in 2016 by the IRS Chief Counsel’s Office (the “Memorandum”). The Memorandum was prompted by the issue of whether cash rewards paid to an employee through a wellness program can be excluded from the employee’s income, either as payments for “medical care” (Code Section 105) or “medical care coverage” (Code Section 106). After denying the excludability of cash incentives under these Code sections on the basis that cash incentives are not medical care or coverage, the Memorandum turns to a discussion of the possibility of exclusion under the de minimis fringe benefit rules of Code Section 132.
Code Section 132(e) defines a de minimis fringe benefit as “any property or service the value of which is (after taking into account the frequency with which similar fringes are provided by the employer to the employer’s employees) so small as to make accounting for it unreasonable or administratively impractical.” Note that the definition is about “property or service,” not cash; the only exceptions to this, under Treas. Reg. Sec. 1-132-6(c), are cash paid for overtime meals and local transportation.
As for the value of goods or services, the IRS does not provide a dollar threshold or formula for determining what amount may be de minimis, requiring employers to make that determination based on facts and circumstances.
The IRS has illustrated this with the example of a $5 per day taxi fare paid by the employer to an employee to commute to work. Local transportation is an acceptable type of cash payment to meet a de minimis standard, and $5 is a very small amount, but the regularity of the payment means, in the aggregate over time, it is not de minimis, and therefore must be accounted for as taxable wages to the employee. For additional examples and discussion see IRS Publication 15-b.
In the wellness program context, rewards may take many forms, such as:
- An object like a water bottle, a T-shirt, or a Fitbit fitness tracker
- Payment or reimbursement of gym membership fees
- Gift cards or gift certificates
Let’s look at these examples one-by-one:
- An Object May Sometimes be Excludible from Compensation. The Memorandum specifies such wellness program rewards as a tee shirt as being a de minimis fringe benefit, and therefore excludible from taxable wages, even though it is not medical care. A water bottle would meet the same criteria, being “property…the value of which…is so small as to make accounting for it unreasonable or administratively impractical.” But is a Fitbit fitness tracker, generally valued at over $100, “so small” that its value would be unreasonable or administratively impractical to account for? That would be a more difficult position to take.
- Payment or Reimbursement of Gym Membership is Non-Excludible Cash. The Memorandum specifically states that payments or reimbursements for a gym membership are taxable wages, as non-excludible cash.
- Gift Cards or Gift Certificates, as Cash Equivalents, are Always Non-Excludible. In response to the popularity of gift cards and gift certificates as a form of reward, the IRS issued a Technical Advice Memorandum in 2004 (the “TAM”), providing that a gift certificate, regardless of how small the amount or infrequently given, is a “cash equivalent benefit” and is therefore not excludable as a de minimis fringe benefit. The TAM has a helpful, detailed analysis of this issue.
How should an employer (or plan administrator) deal with this issue?
The first step is to be aware of the issue and to review how the payroll system is set up to ensure that all benefits that should be included in income (and therefore plan contribution calculations) are being properly coded. This will also mean reviewing the payroll system for this issue whenever a new item of compensation is added.
Another possible action an employer could take to address this type of compensation is to amend the plan’s definition of plan compensation to exclude non-cash and cash-equivalents from the definition of plan compensation. While this may simplify plan contribution calculations, it will not address the employment taxation issue of these types of compensation. In addition, where a definition of plan compensation is customized beyond statutory safe harbors, special testing may be required to demonstrate that the definition is nondiscriminatory, thereby adding additional administrative complexity and cost.
If an employee receives a benefit that is includible in taxable wages, then it needs to be included in compensation for plan purposes (unless specifically excluded as discussed above). How does this work for deferrals where the benefit is an object or a gift card, or other tangible item that can be easily reduced to cash and deferred from? In that case, the employer will need to impute (attribute) income to the employee and make deferrals from the liquid cash compensation in an amount that considers the non-liquid compensation imputed to the employee.
Employers may want to review whether these items of compensation can be eliminated or restructured to meet the de minimis fringe benefit exclusion. More tee shirts and fewer Fitbits?
The lesson to take from this discussion is to not disregard items of benefit to employees just because they are “small amounts” or tangible items that are inconvenient to deal with. The IRS has issued relatively clear guidance on this issue, and yet it seems often to remain a surprise to employers and therefore a potential pitfall. Plan compensation is always a compliance challenge that requires oversight by plan officials. If you have questions about plan compensation, or want assistance with a plan compensation review, contact a KLB Benefits Law Group attorney.