Providing Sec. 132 Fringe Benefits to S Corporation Employees

Editor: Albert B. Ellentuck, Esq.

S corporations can offer employees the same fringe benefits as other business entities; however, so-called 2% shareholders (shareholders owning more than 2% of the corporation’s outstanding stock on any day during the S corporation’s tax year, considering both direct and constructive ownership) are treated as partners for fringe benefit purposes. Because partners generally are considered self-employed persons rather than employees, tax-favored treatment (i.e., corporate deductibility and employee exclusion from income) for employee fringe benefits paid on behalf of 2% shareholders appears to be unavailable unless a specific statute treats a partner as an employee.

Sec. 132 fringe benefits are an exception. Sec. 132 fringe benefits (also known as work-related or statutory fringe benefits) include qualified employee discounts, no-additional-cost services, working condition fringe benefits, de minimis fringe benefits, on-premises athletic facilities, qualified transportation fringe benefits, qualified moving expense reimbursements, and qualified retirement planning services. All Sec. 132 fringe benefits, except for qualified transportation fringe benefits and qualified moving expense reimbursements, are available on a tax-favored basis to 2% shareholders.

No-Additional-Cost Services

No-additional-cost services are excluded from income if the service is sold by the S corporation in the line of business in which the employee performs services and the S corporation does not incur any significant additional costs (including forgone revenue) in providing these services to the employee (Sec. 132(b); Regs. Sec. 1.132-2(a)). The nondiscrimination rules of Regs. Sec. 1.132-8 apply, and only excess capacity services (such as hotels; transportation by aircraft, train, bus, subway, or cruise line; or telephone services) qualify for the exclusion. Nonexcess capacity services (e.g., facilitating stock purchases by a brokerage house, providing legal services to law firm employees, or leasing property) are not eligible for the exclusion but may be eligible for the qualified employee discount exclusion.

Qualified Employee Discounts

A qualified employee discount under Sec. 132(c) is a price reduction provided to an employee on property or services generally offered to outside customers in the S corporation’s ordinary course of business. A common example is an employee discount for retail store employees. The employee must perform services in that line of business to qualify for the income exclusion under Regs. Sec. 1.132-3(a), and the nondiscrimination rules found in Regs. Sec. 1.132-8 apply. Employees cannot exclude discounts on real and investment-type property from income.

For qualified property, the discount cannot exceed the gross profit percentage at which the employer offers the property to customers. For services, the discount cannot exceed 20% of the price at which the employer offers the services to customers. Any discount over these limits is a taxable fringe benefit (Regs. Sec. 1.132-3(e)).

Working Condition Fringe Benefits

A working condition fringe benefit includes property or services provided to an employee that the employee could deduct as a trade or business expense (or as a depreciable asset) if the employee had to pay for it (Sec. 132(d); Regs. Sec. 1.132-5(a)(1)). Examples include on-the-job training, professional dues, business-related magazine subscriptions, certain outplacement services, business use of a company car, and business travel and entertainment. Nondiscrimination rules do not apply.

If the employee uses the property or service directly in the employer’s business, such as the use of an employer-provided auto on a business trip or for local transportation between branches or plant locations, a clear business connection exists. If the employee does not use the property or service or uses it only indirectly in the employer’s trade or business, the proper approach is to determine if, under the facts and circumstances, the employer derives a substantial business benefit from the property or services that is distinct from the benefit it would derive from paying compensation (Regs. Sec. 1.132-5(a)(2), Examples (3) and (4)).

Many employers have programs to assist current (and sometimes terminated) employees in finding other employment. The assistance can be in-house or through an outside firm and can include counseling and testing as well as help with résumé writing, job search strategy, and interview training. For employer-provided outplacement services to be considered a working condition fringe benefit, the employer must derive a substantial business benefit. Examples can include promoting a positive corporate image, maintaining employee morale, and reducing the likelihood of wrongful termination suits.

De Minimis Fringe Benefits

De minimis fringe benefits include property or services provided to employees that have such a small value that accounting for them would be impractical (Sec. 132(e); Regs. Sec. 1.132-6(a)). Included in this category are occasional employee parties or picnics; coffee and doughnuts; occasional use of the copy machine; typing of personal letters by the company secretary; and local telephone calls.

In general, the nondiscrimination rules do not apply to de minimis fringe benefits. Thus, a de minimis fringe benefit may be excludable even if it is provided to highly compensated or key employees.

The following are not excludable as de minimis fringe benefits (Regs. Sec. 1.132-6(e)(2)):

  • Season tickets to sporting or theatrical events;
  • The commuting use of an S corporation–provided vehicle more than one day per month;
  • Membership in a private country club or athletic facility; and
  • Use of corporate owned or leased facilities (such as a hunting lodge or boat) for a weekend.

Job-Related Education

Employer payments or reimbursements for job-related educational expenses also can be excluded from the employee’s income as a working condition fringe benefit. Job-related qualifying education is education that (1) is required by an employer or the law to keep a present salary, status, or job; or (2) maintains or improves skills required for present work (Regs. Sec. 1.162-5). However, education expenses will not qualify for the exclusion if the education is needed to meet the minimum job requirements or qualifies the employee for a new trade or business. A change of duties is not a new trade or business if they involve the same kind of general work. Nor is a change from one employer to another.

The minimum educational requirements for a job are determined by statutes and regulations, professional or business standards, and the employer. An employee has not necessarily met the minimum requirements simply because he is already doing the work (e.g., an accountant working in a CPA firm who has not obtained his CPA certificate has not met the minimum requirement until he obtains his certificate). Once an employee has completed the education or experience required for a professional license, the expenses necessary to maintain a license or status (including dues) are ordinary and necessary expenses. If the minimum requirements change (for example, the employer or the law requires more education) or if recertification or redesignation must occur, any additional education needed to meet the new or continuing requirements is qualifying education.

Educational expenses qualifying for working condition fringe benefit treatment include tuition, books, supplies, tools, lab fees, seminar registration fees, and similar items. Some transportation expenses qualify, such as the cost of going directly from work to school (but not from home to school) and, for temporary or short-term classes or seminars, the cost of the entire round trip. Other qualifying expenses include correspondence courses, tutoring, and formal training.

Employees can incur job-related educational costs for virtually any type of education, including formal university training; professional development or enrichment seminars sponsored by professional societies or trade organizations; and in-house training. Education during a vacation, temporary leave, or other temporary absence also can be related to the employee’s present job. If the employee stops work for a year or less and then returns to the same kind of work, the absence is temporary (IRS Publication 970, Tax Benefits for Education , p. 66 (2011)).

Club Dues

No deduction is allowed for dues paid for membership in any club organized for business, pleasure, recreation, or other social purposes (Sec. 274(a)(3)). The purposes and activities of a club, and not its name, are the determining factors. Clubs in this category include country clubs, golf and athletic clubs, health clubs, airline clubs, hotel clubs, and clubs operated to provide meals under circumstances generally conducive to business discussions. Unless the facts show otherwise, the following are not within this category: business leagues, trade associations, chambers of commerce, boards of trade, real estate boards, professional organizations (such as bar and medical associations), and civic or public service organizations (such as Kiwanis, Lions, Rotary, and similar organizations) (Regs. Sec. 1.274-2(a)(2)(iii)). Accordingly, dues paid to such organizations are deductible.

Nondeductible commercial athletic or country club dues may qualify as a working condition fringe benefit (i.e., can be excluded from the employee’s income) if the employee substantiates a business connection. A business connection exists if the employee uses the club primarily to further the S corporation’s business. Also, to qualify as a working condition fringe benefit, the S corporation cannot deduct the dues as compensation (Regs. Sec. 1.132-5(s)).


If there are substantial noncompensatory business reasons for an employer to provide an employee with a cellphone, the employee’s business use of the phone is a tax-free working condition fringe benefit (Notice 2011-72). Examples of noncompensatory business reasons include an employer’s need to contact the employee at all times for work-related emergencies, the employer’s requirement that the employee be available to speak with clients when the employee is away from the office, and the employee’s need to speak with clients located in other time zones at times outside the employee’s normal work day. If the employer provides a cellphone for compensatory reasons (e.g., to promote employee morale), only the business use qualifies as a tax-free working condition fringe benefit.

Rules similar to those in Notice 2011-72 apply to employer reimbursements to employees for the business use of the employee’s personal cellphone (SBSE-04-0911-083). Employers that require employees, primarily for noncompensatory business reasons, to use their personal cellphones for business purposes may treat reimbursements of the employee’s expenses for reasonable cellphone coverage as nontaxable. This treatment does not apply to reimbursements of unusual or excessive expenses or reimbursements that replace a portion of the employee’s regular wages.

This case study has been adapted from PPC’s Tax Planning Guide—S Corporations, 26th Edition, by Andrew R. Biebl, Gregory B. McKeen, George M. Carefoot, James A. Keller, and Kimberly Drechsel, published by Practitioners Publishing Co., Fort Worth, Texas, 2012 (800-323-8724; ).


Albert Ellentuck is of counsel with King & Nordlinger LLP in Arlington, Va.


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