Which tax-free fringe benefits can passthrough owners claim?
Partnerships, limited liability companies treated as partnerships (LLCs), and S corporations (collectively referred to as "passthroughs") have distinct tax and nontax advantages.
However, entrepreneurs considering these forms of business should be aware that fewer tax-free and tax-favored fringe benefits are available to owners of passthroughs than to shareholder-employees of C corporations.
Let's review which fringe benefits can be made available on a tax-preferred basis to partners, members of LLCs, and more-than-2% S shareholder-employees. It helps to know this if you are thinking of or already are operating a business as a passthrough, and are looking for ways to maximize tax-free compensation.
For purposes of this article, we will refer to the owners these rules apply to simply as "partners" since, unless otherwise noted, the tax consequences of fringes for members of LLCs and for more-than-2% S shareholder-employees are the same as they are for partners.
Working condition fringe benefits. Property or services supplied by an employer to an employee are tax-free working condition fringe benefits (WCFBs) if the employee could take a business expense deduction under the tax code if paid for himself. For WCFB purposes, the term "employee" includes partners who perform services for the partnership.
Thus, partners may receive the following WCFBs tax-free: • Business-related use of a company auto, if properly substantiated. The personal-use value of the auto must, however, be treated as compensation income. • The business-use portion of company paid country club dues, even though the dues are completely nondeductible. • Job-related education expenses paid by the firm. • Job placement assistance. • The use of a cell phone provided to an employee primarily for noncompensatory business reasons.
De minimis fringe benefits. For purposes of the tax-free de minimis fringe benefit rules, "employees" include any recipient of a fringe benefit. So, for instance, partners are entitled to get tax-free supper or supper money or local transportation fare if provided on an occasional basis in connection with overtime work.
Other de minimis fringes include: • Traditional birthday or holiday gifts of property (BUT NOT CASH) with a low fair market value (an undefined term in the regs), occasional theater or sporting event tickets, and fruit, books, or similar items provided under special circumstances (such as illness, outstanding performance, or family crisis). • Traditional awards (the proverbial gold watch) upon retirement after lengthy service
Dependent care assistance. Partners are eligible for the dependent care assistance exclusion. The exclusion is for amounts provided under a written plan of the employer and is limited annually to $5,000 ($2,500 for a married person filing separately).
However, for a plan to qualify as a dependent care assistance program, no more than 25% of the amounts paid by the employer for dependent care assistance during the year may be provided for the class of individuals who are shareholders or owners (or their spouses or dependents), each of whom (on any day of the year) owns more than 5% of the stock or of the capital or profit interest in the employer.
Educational assistance programs. Employers can set up educational assistance programs under which employees can receive up to $5,250 per year of graduate- or undergraduate-level educational assistance tax-free, whether or not job-related. Employees for this purpose include partners who have earned income from their partnerships, which, in turn, are treated as employers of these partners.
However, no more than 5% of the cost of annual benefits may be provided for the class of individuals (and their spouses and dependents) each of whom (on any day of the year) own more than 5% of the stock or of the capital or profits interest in the employer.
Note that this exclusion expires after December 31, 2012 unless Congress acts to extend it.
Thus, absent further legislation, a partner's income will include any amounts paid by the partnership in providing educational assistance to the partner for courses beginning after December 31, 2012, unless those amounts are otherwise deductible as a business expenses.
Athletic facilities. The tax code's exclusion for on-premises athletic facilities (e.g., swimming pool, gym) is available to partners (and their spouses and/or children).
No-additional-cost services and qualified employee discounts. For purposes of these tax-free fringes, partners who perform services for a partnership are treated as employed by the partnership.
Transportation fringes. A partner cannot exclude qualified transportation fringes like other employees.
However, under the de minimis benefit rules, tokens or fare cards provided by a partnership to a partner that enable the recipient to commute on a public transit system are excludable from income if the value of the tokens or fare cards in any month doesn't exceed $21.
In addition, if a partner would be able to deduct the cost of parking as a business expense (e.g., parking cost incurred in connection with traveling from the regular office to another business office), the value of the free or reduced-cost parking is excludable as a WCFB.
