IRS guidance offers useful reminders about employee discount plans

By Allen F. Tobin, J.D., New York City, and David J. Holets, CPA, Indianapolis

Editor: Howard Wagner, CPA
The IRS recently released Field Attorney Advice 20171202F, which provides guidance on the taxability of an employee discount plan.
Under the discount plan as described (with identifying details redacted), employees could designate a certain number of individuals, including themselves, to receive a discount on services from the employer. Designated individuals could include spouses or domestic partners, family members, and friends of the employee. Individuals eligible for the discount were required to create an account from which they received a discount of a certain percentage off the published rates for the employer's services. The employer claimed the discount was, in most cases, less than the discount offered to the employer's large customers or under certain customer discount programs but did not provide supporting evidence of this to the examining agent.

Sec. 132(a)(2) allows employers to provide a qualified employee discount that is excludable from an employee's taxable income. A qualified employee discount is defined under Sec. 132(c) as a discount with respect to qualified property or services that:

  • In the case of property, does not exceed the gross profit percentage of the price at which the property is offered to customers; or
  • In the case of services, does not exceed 20% of the price at which the services are offered to customers.

Qualified property does not include real property or property of a type commonly held for investment. Qualified property and services must be offered for sale in the ordinary course of the taxpayer's trade or business in which the employee provides services. For example, employee discounts provided on merchandise only available to employees through a company store will not qualify for exclusion as an employee discount plan.

Qualified employees who can receive tax-free discounts generally include the employee, his or her spouse and dependent children, former employees who retired or left because of disability, and the widow or widower of a deceased employee (Sec. 132(h)).

Regs. Sec. 1.132-3 includes several additional clarifying rules:

  • Discounts in excess of the amounts allowed under Sec. 132(a)(2) are includible in the employee's taxable income.
  • The qualified employee discount exclusion does not apply to property or services provided by a different employer through a reciprocal agreement to provide discounts to employees of the other employer.
  • Property or services may be provided directly or through a third party. For example, an employee of an appliance manufacturer may be allowed a discount when purchasing the appliance through a third-party retailer. However, to qualify for the exclusion, the employee may not receive additional rights, such as an extended warranty, not offered to customers in the employer's ordinary course of business.
  • The price at which an employer offers property or services to its customers controls the price used to determine whether an employee discount is excludable. In cases where the employer offers a discounted price to a discrete customer group, and the sales at that discounted price comprise at least 35% of gross sales for a representative period, then in determining the employee discount, the discounted price is considered the price at which the service is being offered to customers.

Although the response from the Office of Chief Counsel (OCC) to the examining agent was heavily redacted, the published portion of the response is consistent with the law and clearly unfavorable to the taxpayer. First, the OCC agreed with the examiner that the discount pertained to services, not property. Second, regarding who is considered an employee, the OCC confirmed that only individuals identified as employees under Sec. 132(h) or the related regulations qualified for the exclusion of an employee discount from taxable income. Any discount received by someone who was outside the definition of a qualified employee was includible in the wages of the employee who designated that individual.

Third, the OCC confirmed that a rate for property or services lower than a published rate may be used to determine whether an employee discount is qualified for exclusion if at least 35% of gross sales to ordinary customers are made at a discounted rate. However, the employer in this case did not provide sufficient evidence regarding standard discounts provided to corporate customers to prove that the employee discount should be based upon the discount rates provided to those customers, instead of its published rates. Therefore, the employer was required to use the published rates to determine the taxable portion of the discount until the employer provided the required customer discount information. The OCC, noting that the employee discount rate was more than 20% of the published rates, stated that the employer must include the excess discount in the employees' gross income as a taxable fringe benefit and withhold and pay employment taxes on that amount.


Discount plans are a common and easy way to provide an incentive to employees for their service. However, as demonstrated, the rules permitting an employer to exclude the employee discount from taxable income are complex and easy to run afoul of, especially when documentation is poor.

Companies offering employee discount plans should review their plans closely in light of this IRS guidance to determine whether they must make adjustments to align with statutory and regulatory requirements. Current payroll applications should be modified to identify any discounts that must be included in employees' taxable income and include the corresponding information on Forms W-2, Wage and Tax Statement, as well as to perform the applicable withholding. If taxpayers do not have a system that can identify any discounts that are includible in taxable income, they should institute a process to do so and thus comply with statutory and regulatory requirements.


Howard Wagner is a director with Crowe Horwath LLP in Louisville, Ky.

For additional information about these items, contact Mr. Wagner at 502-420-4567 or

Unless otherwise noted, contributors are members of or associated with Crowe Horwath LLP.

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