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  • 8887. How are funds provided to employees through an educational assistance program taxed?

    • An employee may generally exclude from income amounts received pursuant to an employer-sponsored Educational Assistance Program (EAP) that was established in order to fund employee education-related expenses, subject to the maximum limitation discussed below.1 This exclusion was made permanent by EGTRRA 2001 following a number of extensions in preceding years. Amounts received under an EAP may be excluded whether or not the educational expenses are job related.2 An employee cannot exclude from income more than $5,250 in educational assistance benefits in any calendar year.3

      1.     IRC § 127(a)(1).

      2.     Treas. Reg. § 1.127-2(c)(4).

      3.     IRC § 127(a)(2).

  • 8888. What requirements must an education assistance program (EAP) meet in order to receive tax-preferred treatment?

    • The following requirements must be met by an employer-sponsored educational assistance program (EAP) to receive tax-preferred treatment:

      1. Written plan: the program must be a separate written plan of the employer providing educational assistance for the exclusive benefit of the company’s employees.1 A sole proprietor may treat himself as employer and employee and a partnership will be treated as the employer of all self-employed partners.2
      2. Nondiscrimination: the program must benefit employees who qualify under a classification set up by the employer that does not discriminate in favor of highly compensated employees, as defined in IRC Section 414(q). Generally, highly compensated employees are five percent owners or members of the top-paid group of employees. Employees covered by a collective bargaining agreement may be excluded if educational assistance benefits were the subject of good faith bargaining.3
      3. More than five percent owners: the class of shareholders and their spouses and dependents, each of whom owns more than five percent of the employer’s stock, cannot receive more than five percent of the educational benefit amounts.4
      4. Employee choice: a program cannot offer employees a choice between educational assistance and other benefits that are includable in income.5
      5. Funding: an educational assistance program may be funded or unfunded.6
      6. Notification: eligible employees must receive reasonable notification of the program’s availability and benefits.7

      A plan will still be considered in compliance with these requirements even though different types of educational assistance are used more than others or because successful completion of the course or obtaining a certain grade is required or considered in the process of obtaining reimbursement under the plan.8

      Further, a plan will continue to meet the requirements of Section 127(b) even if it provides benefits to former employees. Included in the category of former employees are retirees, persons who were unable to work due to disability, persons whose positions were terminated due to a corporate downsizing, persons who left the employer voluntarily and employees who were involuntarily terminated from their positions.9


      1.     IRC § 127(b)(1).

      2.     IRC § 127(c)(3).

      3.     IRC § 127(b)(2).

      4.     IRC § 127(b)(3).

      5.     IRC § 127(b)(4).

      6.     IRC § 127(b)(5).

      7.     IRC § 127(b)(6).

      8.     IRC § 127(c)(5).

      9.     Treas. Reg. § 1.127-2(h)(1); Rev. Rul. 96-41, 1996-2 CB 8.

  • 8889. What types of “educational assistance” may be provided on a tax-preferred basis through an employer-provided educational assistance program?

    • “Educational assistance,” for purposes of an employer-sponsored educational assistance program (EAP), is generally defined in IRC Section 127 as an employer’s payment of expenses incurred by an employee for education. Expenses such as tuition, fees, books, supplies, equipment and employer-provided courses of instruction including books, supplies and equipment are all included within this definition.1The 2020 CARES Act amended Section 127 so that the definition of educational assistance also includes the payment by an employer, whether paid to the employee or to a lender, of principal or interest on any qualified education loan incurred by the employee for education of the employee.2 The Consolidated Appropriations Act of 2021 extended this student loan repayment benefit through January 1, 2026.


      Planning Point: Employers who offer traditional education assistance programs can extend their programs to also cover student loans, but the total assistance must be capped at $5,250 per employee, per year, or the payments become taxable.


      Educational assistance does not include payments for tools or supplies that the employee may keep after finishing the course of instruction, as well as meals, lodging and transportation. Payment for any course or education involving sports, games or hobbies is not considered to be “educational assistance.”3

      The IRS, in interpreting the IRC definition, has defined a graduate level course as “… any course taken by an employee who has a bachelor’s degree or is receiving credit toward a more advanced degree, if the particular course can be taken for credit by any individual in a program leading to a law, business, medical, or other advanced academic or professional degree.”4

      According to IRS guidance, a course will be considered to begin on the first regular day of class for the courses offered during that term. The date upon which a student registers for a course has no effect on the date the course is considered to have started for purposes of the Section 127 exclusion.


      1.     IRC § 127(c)(1).

      2.     IRC § 127(c)(1)(B).

      3.     IRC § 127(c)(1).

      4.     Notice 96-68, 1996-2 CB 236.

  • 8890. What reporting requirements apply to employers who provide assistance to employees through an educational assistance program?

    • Until 2002, an employer who maintained an Educational Assistance Program under IRC Section 127 was required to file an information return (Schedule F to the Form 5500) for each year that the program is in effect. The information return had to include the number of employees currently working, the number of employees eligible to participate in the plan, the number of employees actually participating, the total plan cost, and the number of highly compensated employees. In addition, the employer was required to identify itself and state the type of business in which it is engaged.1Notice 2002-24, however, suspended these reporting requirements with respect to EAPs and certain other employee fringe benefits. Employers are relieved of the obligation to file under Section 6039D until the IRS provides further notice.2

      Notice 2002-24 superseded Notice 90-24, which exempted plans under Section 127 from furnishing the additional information concerning highly compensated employees that was required by the TRA ’86 amendments to Section 6039D.

      This reporting relief applies to any plan year that begins prior to the issuance of further guidance on this subject by the IRS.3


      1.     IRC § 6039D.

      2.     2002-16 IRB 785.

      3.     Notice 90-24, 1990-1 CB 355.

  • 8891. What is a dependent care assistance program?

    • A dependent care assistance program is a separate written plan of an employer for the exclusive benefit of providing employees with payment for or the provision of services that, if paid for by the employee, would be considered employment-related expenses under IRC Section 21(b)(2).1“Employment-related expenses” are amounts incurred to permit the taxpayer to be gainfully employed while he or she has one or more dependents under age 13 (for whom he or she would be entitled to a personal exemption deduction under IRC Section 151(c) absent the suspension of the personal exemption for 2018-2025) or a dependent or spouse who cannot care for themselves. The expenses may be for household services or for the care of the dependents.2

      The plan is not required to be funded.3 A dependent care program may also be provided through a cafeteria plan.4 See Q 8892 for a discussion of the tax treatment of employer contributions to a dependent care assistance program. See Q 8894 on the limitations to the amounts that an employee may exclude from income.


      Planning Point: With so many employees working from home–and scrambling to find childcare options as businesses reopen–many employees are rethinking contributions to dependent care FSAs. The rules governing changes to dependent care FSA contributions are more flexible than health FSAs. Employees are permitted to make mid-year changes in pre-tax contributions if their circumstances relating to the need for dependent care changes. Employees can reduce their contributions if they are working from home and do not need childcare, or can increase the contributions when they return to work and need to provide for increased childcare costs.

      Further, employees who have been furloughed and laid off might want to ask whether their plan contains a spend-down feature. These features are optional, but allow former employees to seek reimbursement for dependent care expenses incurred through the end of the tax year (even if their employment has been terminated). Employers have the option of adding a spend-down feature at any time.



      1.     IRC §§ 129(d)(1), 129(e)(1).

      2.     IRC § 21(b)(2).

      3.     IRC § 129(d)(5).

      4.     See Notice 2005-42, 2005-23 IRB 1204.

  • 8892. Is dependent care assistance provided by an employer as a fringe benefit taxable income to the employee? Do any nondiscrimination requirements apply in order for these benefits to be received tax-free?

    • Non-highly compensated employees are permitted to exclude limited amounts (see Q 8894) received under an employer-sponsored dependent care assistance program for each tax year.1 For highly compensated employees to enjoy the same income tax exclusion, the program must meet the following additional requirements:

      (1)     Plan contributions or benefits must not discriminate in favor of highly compensated employees as defined in IRC Section 414(q) or their dependents.

      (2)     The program must benefit employees in a classification that does not discriminate in favor of highly compensated employees or their dependents.

      (3)     No more than 25 percent of the amounts paid by the employer for dependent care assistance may be provided for the class of shareholders and owners, each of whom owns more than five percent of the stock or of the capital or profits interest in the employer (certain attribution rules under IRC Section 1563 apply).

      (4)     Reasonable notification of the availability and terms of the program must be provided to eligible employees.

      (5)     The plan must provide each employee, on or before January 31, with a written statement of the expenses or amounts paid by the employer in providing such employee with dependent care assistance during the previous calendar year.

      (6)     The average benefits provided to non-highly compensated employees under all plans of the employer must equal at least 55 percent of the average benefits provided to the highly compensated employees under all plans of the employer.2

      The dependent care assistance plan may disregard any employee with compensation that is less than $25,000 annually for purposes of the 55 percent test if benefits are provided through a salary reduction agreement.3 For this purpose, compensation is defined in IRC Section 414(q)(4), but regulations may permit an employer to elect to determine compensation on any other nondiscriminatory basis.4

      For purposes of the eligibility and benefits requirements (described in items (2) and (6) above), the employer may exclude the following employees from consideration:

      (1)     Employees who have not attained age 21 and completed one year of service (provided all such employees are excluded).

      (2)     Employees covered by a collective bargaining agreement (provided there is evidence of good faith bargaining regarding dependent care assistance).5

      A program will not fail to meet the requirements above, other than the 25 percent test applicable to more than five percent shareholders, or the 55 percent test applicable to benefits, merely because of the utilization rates for different types of assistance available under the program. The 55 percent test may be applied on a separate line of business basis.6


      1.     IRC § 129(d)(1).

      2.     IRC § 129(d).

      3.     IRC § 129(d)(8)(B).

      4.     IRC § 129(d)(8)(B).

      5.     IRC § 129(d)(9).

      6.     See IRC § 414(r).

  • 8893. Is the employer entitled to a deduction for amounts paid to employees under a dependent care assistance program?

    • Yes. The employer’s expenses incurred in providing benefits under a dependent care assistance program generally are deductible to the employer as ordinary and necessary business expenses under IRC Section 162.

  • 8894. Is there a limit to the amount that an employee may exclude for payments paid by an employer under a dependent care assistance program?

    • Editor’s Note: The American Rescue Plan Act (ARPA) allowed employers to increase contribution limits for dependent care assistance programs to $10,500 for 2021. The 2021 CAA also allowed participants to carry over unused DCAP benefits from 2020 or 2021 into the following plan year. Initially, there was some confusion over the tax consequences if a participant took advantage of both the increased contribution limit and carryover relief. Notice 2021-26 clarified the issue by providing that participants may take advantage of both (1) tax-free reimbursements of contributions made during the 2021 plan year up to the maximum $10,500 limit and (2) tax-free reimbursements of amounts carried over from the prior year. In other words, a participant with a $5,000 carryover amount from 2020 and a $10,500 contribution in 2021 could take tax-free distributions up to $15,500 in 2021 if that participant incurred enough qualifying expenses during the 2021 plan year. See below for a discussion of the otherwise applicable limitations.An employee may exclude up to $5,000 paid by the employer for dependent care assistance provided during a tax year.1 The excludable amount is reduced to $2,500 for a married individual filing separately. Additionally, the excludable amount cannot exceed the earned income of an unmarried employee or the lesser of the earned income of a married employee or the earned income of the employee’s spouse.2

      An employee cannot exclude from gross income any amount paid to an individual with respect to whom the employee or the employee’s spouse is entitled to take a personal exemption deduction under IRC Section 151(c) (prior to 2018, when the personal exemption was suspended for 2018-2025) or who is a child of the employee under 19 years of age at the close of the taxable year, or the spouse.3

      If the dependent care assistance is provided by way of on-site facilities (such as an on-site day care center), the amount of dependent care assistance excluded is based on a dependent’s use of the facilities and the value of the services provided with respect to that dependent.4

      The amount of employment-related expenses available in calculating the dependent care credit of IRC Section 21 is reduced by the amount excludable from gross income under IRC Section 129.5


      1.     IRC § 129(a). See IRS Pub. 503.

      2.     IRC § 129(b).

      3.     IRC § 129(c).

      4.     IRC § 129(e)(8).

      5.     IRC § 21(c).

  • 8895. What is the new credit for employers that offer paid family and medical leave to employees?

    • The 2017 tax reform law created a new temporary tax credit for employers that provide paid family and medical leave to emgployees.1 See Q 8894. The credit is an amount equal to 12.5 percent of the wages that are paid to qualifying employees during a period where the employee was on family and medical leave if the employee is paid 50 percent of the normal wages that he or she would receive from the employer. The credit increases by 0.25 percentage points (but can never exceed 25 percent) for each percentage point by which the rate of payment exceeds 50 percent of wages.For purposes of the 50 percent of wages requirement, overtime and discretionary bonuses are excluded from the wages that are normally paid. Wages paid by a third-party payor, such as an insurance company or professional employer organization, are taken into account if based on services provided by the employee to the eligible employer. Similarly, amounts paid under the employer’s short-term disability program are taken into account. The rate of pay does not have to be uniform.

      Example: The employer provides six weeks paid leave for a qualifying employee for the birth or adoption of a child, at a rate of 100 percent of wages. The same employer provides two weeks of annual leave paid at a rate of 75 percent of wages for all other FMLA purposes. The policy satisfies the paid leave requirements. Note that the rate of pay cannot vary based on the employee’s classification (i.e., the employee cannot be paid leave only to employees not covered by a collective bargaining agreement).2

      Only 12 weeks of family and medical leave can be taken into account for any one employee. Further, all part-time employees must be allowed a pro-rated amount of paid family and medical leave.3 Any leave paid for by the state or local government is not taken into account.4

      In order to qualify, employers must have a written policy in place to allow all qualifying full-time employees no less than two weeks of paid family and medical leave each year. The written policy may be set forth in a single document, or in multiple documents that cover different classes of employee or different types of leave. The policy must be in place before the leave for which the employer claims the credit is taken, except as otherwise provided in a transition rule. A policy is considered to be “in place” at the later of its adoption date or effective date. Under the transition rule, the policy is considered “in place” as of its effective date, rather than a later adoption date, for the first tax year beginning after December 31, 2017 if the policy (a) is adopted before December 31, 2018 and (b) the employer complies with the terms of the policy for the entire retroactive period.5

      The employer need not be subject to title 1 of the Family and Medical Leave Act of 1993 (FMLA) to be a qualifying employer. However, employers who employee at least one employee who is not subject to Title 1 of the FMLA must include and comply with “noninterference” language in the required written policy. This language must generally state that the employer will not attempt to interfere with the employee’s exercise of his or her rights under the written policy, and will not discharge or discriminate against an employee who opposes any practice prohibited by the written policy.6

      “Qualifying employees” are those who have been employed by the employer for one year or more and who had compensation that did not exceed 60 percent of the compensation threshold for highly compensated employees7 in the previous year.8 The employer can use any reasonable method to determine how long the employee has been employed. Further, there is no minimum hours requirement in determining how long the employee has been employed, and requiring the employee to work a minimum number of hours would not be treated as a reasonable method for determining whether an employee has been employed for one year (the requirement that an employee work at least 1,250 hours to be an FMLA-eligible employee does not apply to the Section 45S credit).

      If the employee is otherwise a qualifying employee, the employer’s written policy cannot exclude any class of employees (although the amount of paid leave provided may be pro-rated for part-time employees who customarily work fewer than 30 hours per week). For part-time employees, the paid leave ratio must be at least equal to the ratio of the expected weekly hours worked by a qualifying employee who is a part-time employee to the expected weekly hours worked by an equivalent qualifying employee who is not a part-time employee.9


      Planning Point: The employee must be a qualifying employee at the date the paid leave is taken for the credit to apply.


      “Family and medical leave” means leave as defined under Section 102(a)(1)(a)-(e) or Section 102(a)(3) of the FMLA. It includes leave taken as a result of:

      • the birth of a child;
      • adoption or fostering of a child;
      • the need to care for the employee’s spouse, child or parent who has a serious health condition;
      • a serious health condition that makes the employee unable to perform his or her job;
      • issues arising due to the employee’s spouse, child or parent being on covered active duty (or being notified of an impending order to covered duty); or
      • the need to care for a service member who is the employee’s spouse, child, parent or next of kin. Paid leave that is vacation leave, personal leave or other medical or sick leave does not qualify for the new tax credit.10

      The employer’s policy must strictly apply to only leave that qualifies as an FMLA purpose—meaning that the employer cannot give the employee a choice between an FMLA purpose and vacation leave, for example. This is the case even if the employee uses the leave for a qualifying purpose. The IRS has carved out an exception for situations where the employer provides leave to care for a group of individuals, and one or more of those individuals is not a qualified individual for FMLA purposes. In this case, the policy will continue to qualify, except that if an employee takes the leave to care for a non-qualified individual, the employer will not be entitled to the credit with respect to that employee.11

      This credit was originally only available for tax years beginning after December 31, 2017 and before December 31, 2019, but was extended through 2025. It is a part of the general business tax credit.12 The credit is also allowed against the alternative minimum tax (AMT).

      Pursuant to IRS FAQ, an employer who received the credit for paid family and medical leave must reduce its deduction for wages or salary paid to the employee by the amount of the credit that is received. Wages considered in determining any other general business credit may not be taken into account by the employer in determining the credit for paid family and medical leave.


      Planning Point: Although the credit can be taken against the AMT, because of the increased AMT exemption amounts and compensation limits that apply to the credit itself, many clients will be unable to use the credit against the AMT. Also note that the corporate AMT has been repealed entirely.



      1.     IRC § 45S (added by the 2017 tax reform legislation).

      2.     Notice 2018-71.

      3.     IRC § 45S(c)(1).

      4.     IRC § 45S(c)(4).

      5.     Notice 2018-71.

      6.     Notice 2018-71.

      7.     Under IRC § 414(g)(1)(B).

      8.     IRC § 45S(d).

      9.     Notice 2018-71.

      10.   IRC § 45S(e).

      11.   Notice 2018-71.

      12.   IRC § 45S(a)(1).

  • 8896. What reporting requirements apply in connection with amounts paid by an employer under a dependent care assistance program?

    • The employee must identify on the tax return all persons or organizations that provide care for the employee’s dependent. This includes the name, address, and taxpayer identification number of the person (name and address in the case of a tax-exempt 501(c)(3) organization) providing the services. If the employee does not have the information, then the employee can use form W-10, Dependent Care Provider’s Identification and Certification to request this information from the provider. The IRS may disallow a credit to an employee who fails to provide this information unless the taxpayer can show that he or she exercised due diligence in attempting to obtain the information. To show due diligence, the taxpayer should attach a statement explaining that the provider refused to complete the W-10.1As is the case with employer-provided educational assistance programs, the IRS has suspended the reporting requirements that are otherwise applicable to dependent care programs until further notice.2

      Prior to this suspension, IRC Section 6039D generally required an employer maintaining a dependent care assistance plan to file an information return with the IRS that provided:

      (1)     its number of employees;

      (2)     the number of employees eligible to participate in the plan;

      (3)     the number of employees participating in the plan;

      (4)     the number of highly compensated employees (“HCEs”) of the employer;

      (5)     the number of HCEs eligible to participate in the plan;

      (6)     the number of HCEs actually participating in the plan;

      (7)     the cost of the plan;

      (8)     the identity of the employer; and

      (9)     the type of business in which it is engaged.


      1.     IRC § 129(e)(9).

      2.     Notice 2002-24, 2002-16 IRB 785; Notice 90-24, 1990-1 CB 335.

  • 8897. What is a cafeteria plan? What information must an employer provide in order to establish a cafeteria plan for its employees?

    • A cafeteria plan (or “flexible benefit plan”) is a written plan that gives employees the option of choosing between cash and “qualified benefits.” With certain limited exceptions, a cafeteria plan cannot provide for deferred compensation, which generally means that the taxpayer-employee must use all benefits within the tax year.1Some cafeteria plans provide for salary reduction contributions by the employee and others provide benefits in addition to salary. In either case, the employee-participants are given the opportunity to purchase certain benefits with pre-tax dollars.

      A plan may provide for automatic enrollment whereby an employee’s salary is reduced to pay for “qualified benefits” unless the employee affirmatively elects cash.2

      Under the 2007 proposed regulations (effective for plan years beginning on or after January 1, 2009), the written plan document must contain:

      (1)     a specific description of the benefits, including periods of coverage;

      (2)     the rules regarding eligibility for participation;

      (3)     the procedures governing elections;

      (4)     the manner in which employer contributions are to be made, such as by salary reduction or non-elective employer contributions;

      (5)     the plan year;

      (6)     the maximum amount of employer contributions available to any employee stated as (a) a maximum dollar amount or maximum percentage of compensation or (b) the method for determining the maximum amount or percentage;

      (7)     a description of whether the plan offers paid time off, and the required ordering rules for use of non-elective and elective paid time off;

      (8)     the plan’s provisions related to any flexible spending arrangements (FSA) included in the plan;

      (9)     the plan’s provisions related to any grace period offered under the plan; and

      (10)   the rules governing distributions from a health FSA to employee health savings accounts (HSAs), if the plan permits such distributions (see Q 8834).3

      The plan document need not be self-contained, but may incorporate by reference separate written plans.4

      Participants should note that, under the ACA, for purchases made after 2010 and before 2020, the cost of an over-the-counter medicine or drug could not be reimbursed from FSAs (Q 8902), HRAs (Q 8805) or HSAs (Q 8825) unless a prescription was obtained.5 This rule did not affect insulin, even if purchased without a prescription, or other health care expenses such as medical devices, eyeglasses, contact lenses, co-pays and deductibles. FSA and HRA participants may use debit cards to buy prescribed over-the-counter medicines, if certain requirements are met (see Q 8805).6 The prescription requirement was removed for over-the-counter drugs beginning in 2020 in response to the COVID-19 pandemic.7

      After 2013, a $2,500 limit (as indexed for inflation) applies to the amount that can be contributed to an FSA (see Q 8902) and, in 2014, a new optional $500 carryover provision can be incorporated into a health FSA.8

      Former employees may participate in an employer’s cafeteria plan (although the plan may not be established predominantly for their benefit), but self-employed individuals may not.9 A full-time life insurance salesperson who is treated as an employee for Social Security purposes will also be considered an employee for cafeteria plan purposes (see Q 8732).10

      See Q 8898 for an explanation of benefits that may be offered through cafeteria plans. See Q 8899 for a discussion of the nondiscrimination requirements that apply to cafeteria plans. See Q 8900 for a discussion of “simple” cafeteria plans.


      1.     IRC § 125(d).

      2.     Rev. Rul. 2002-27, 2002-1 CB 925.

      3.     Prop. Treas. Reg. § 1.125-1(c), 72 F.R. 43938 (Aug. 6, 2007).

      4.     Prop. Treas. Reg. § 1.125-1(c)(4).

      5.     P.L. 111-148.

      6.     IRS News Release IR-2010-128 (Dec. 23, 2010).

      7.     CARES Act § 3702.

      8.     Notice 2012-40, 2012-26 IRB 1046.

      9.     Prop. Treas. Reg. § 1.125-1(g)(2).

      10.   IRC § 7701(a)(20); Prop. Treas. Reg. § 1.125-1(g)(1)(iii).

  • 8898. How can a cafeteria plan be used by employers to offer employee benefits?

    • An employer may offer employees who are participants in a cafeteria plan a choice among two or more benefits consisting of cash and qualified benefits.1 A cash benefit is not strictly limited to cash, but includes a benefit that may be purchased with after-tax dollars or the value of which is generally treated as taxable compensation to the employee (provided the benefit does not constitute deferred compensation).2A qualified benefit is a benefit that is not includable in the gross income of the employee because of an express statutory exclusion and because the benefit constitutes deferred compensation. Contributions to Archer Medical Savings Accounts, qualified scholarships, educational assistance programs, or excludable fringe benefits are not qualified benefits. Products that are advertised, marketed, or offered as long-term care insurance similarly do not qualify as qualified benefits.3

      When insurance benefits, such as those provided under accident and health plans and group term life insurance plans, are provided through a cafeteria plan, the benefit is the coverage under the plan. Accident and health benefits are qualified benefits to the extent that coverage is excludable under IRC Section 106.4 Accidental death coverage offered in a cafeteria plan under an individual accident insurance policy is excludable from the employee’s income under IRC Section 106.5

      Group term life insurance coverage on employee-participants can be offered through a cafeteria plan. Coverage may be offered through the plan even if it exceeds the $50,000 excludable limit under IRC Section 79.6 The application of IRC Section 79 to group term life insurance and IRC Section 106 to accident or health benefits is explained in Q 8789 to Q 8792.

      Accident and health coverage, group term life insurance coverage, and benefits under a dependent care assistance program are still counted as “qualified” benefits even if they must be included in income because a nondiscrimination requirement has been violated.7

      For tax years beginning after 2012, a health flexible spending arrangement (FSA) offered under a cafeteria plan is not a qualified benefit unless the plan limits employees to no more than $2,500 in salary reduction contributions for each tax year (the amount is indexed for later years, to $3,050 in 2023, $2,850 in 2022 and $2,750 in 2021).8 Beginning in 2014, up to $500 ($610 in 2023, $570 in 2022 and $550 in 2020 and 2021)9 of the balance of a health FSA may be carried forward to the subsequent tax year if the FSA incorporates a provision that permits such a carryover.

      A cafeteria plan generally cannot provide for deferred compensation, permit participants to carry over unused benefits or contributions from one plan year to another, or permit participants to purchase a benefit that will be provided in a subsequent plan year. A cafeteria plan, however, may permit a participant in a profit sharing, stock bonus, or rural cooperative plan that has a qualified cash or deferred arrangement to elect to have the employer contribute on the employee’s behalf to the plan.10 After-tax employee contributions to an IRC Section 401(m) qualified plan are permissible benefits under a cafeteria plan, even if the employer makes matching contributions.11

      A cafeteria plan may permit a participant to elect to have the employer contribute to a health savings account (HSA) on the participant’s behalf (see Q 8825 to Q 8837).12 Unlike other benefits, HSA balances may be carried over from one year to another even if they are funded through a cafeteria plan.


      Planning Point: Notice 2020-29 allowed employers to permit certain mid-year elections made during calendar year 2020 that would otherwise be impermissible, including changes to salary reduction contribution elections. The guidance also allowed participants to revoke (or make) an election with respect to health and dependent care FSAs on a prospective basis during 2020 to respond to changing needs during the COVID-19 pandemic. Further, the guidance clarified that the relief for high deductible health plans (HDHPs) and expenses related to COVID-19 (regarding an exemption for telehealth services) may be applied retroactively to January 1, 2020.


      Generally, life, health, disability, or long-term care insurance with an investment feature, such as whole life insurance, or an arrangement that reimburses premium payments for other accident or health coverage extending beyond the end of the plan year cannot be provided under a cafeteria plan.13 Supplemental health insurance policies that provide coverage for cancer and other specific diseases are not treated as providing deferral of compensation and are properly considered accident and health benefits under IRC Section 106.14

      Participants in a cafeteria plan maintained by an educational organization described in IRC Section 170(b)(1)(A)(ii) (i.e., one with a regular curriculum and an on-site faculty and student body) can be permitted to elect postretirement term life insurance coverage. The postretirement life insurance coverage must be fully paid up on retirement and must not have a cash surrender value at any time. Postretirement life insurance coverage meeting these conditions will be treated as group term life insurance under IRC Section 79 (see Q 8681 to Q 8684).15

      Under the Affordable Care Act, plans and issuers that offer dependent coverage must make this coverage available until a child reaches the age of 26.16 Even if a cafeteria plan has not yet been amended to provide coverage for children under age 27, the ACA allows employers with cafeteria plans to permit employees to immediately make pre-tax salary reduction contributions to provide coverage for these children in order to assist with implementation of the expanded coverage requirements.

      Both married and unmarried children qualify for this coverage. This rule applies to all plans in the individual market and to new employer plans, as well as to existing employer plans unless the adult child has another offer of employer-based coverage. Beginning in 2014, children up to age 26 can stay on their parent’s employer plan even if they have another offer of coverage through an employer.

      Employees are eligible for the new tax benefit beginning March 30, 2010 and thereafter if the children are already covered under the employer’s plan or are added to the employer’s plan at any time. For this purpose, a child includes a son, daughter, stepchild, adopted child, or eligible foster child. This “up to age 26” standard replaces the lower age limits that applied under prior tax law, as well as the requirement that a child generally qualify as a dependent for tax purposes.


      1.     IRC § 125(d)(1)(B).

      2.     Prop. Treas. Reg. § 1.125-1(a)(2).

      3.     IRC § 125(f); Prop. Treas. Reg. § 1.125-1(q).

      4.     Prop. Treas. Reg. § 1.125-1(h)(2).

      5.     Let. Ruls. 8801015, 8922048.

      6.     Prop. Treas. Reg. § 1.125-1(k).

      7.     IRC § 129(d); Prop. Treas. Reg. § 1.125-1(b)(2).

      8.     IRC § 125(i).

      9.     Notice 2020-23; Rev. Proc. 2021-45.

      10.   IRC § 125(d)(2).

      11.   Prop. Treas. Reg. § 1.125-1(o)(3)(ii).

      12.   IRC § 125(d)(2)(D).

      13.   Prop. Treas. Reg. § 1.125-1(p)(1)(ii).

      14.   TAM 199936046.

      15.   IRC § 125(d)(2)(C).

      16.   See IRC § 105(b); Notice 2010-38, 2010-1 CB 682.

  • 8899. What nondiscrimination requirements apply to cafeteria plans that provide benefits to highly compensated or key employees?

    • If a cafeteria plan discriminates in favor of highly compensated individuals as to eligibility to participate or as to contributions or benefits, highly compensated participants will be considered in constructive receipt of the available cash benefit, which will prevent these employees from excluding the amounts from income.1“Highly compensated” individuals are officers, shareholders owning more than five percent of the voting power or value of all classes of stock, those who are “highly compensated,” and any of their spouses or dependents. For this purpose, “highly compensated” means (1) any individual or participant who, for the preceding plan year (or the current plan year in the case of the first year of employment), had compensation from the employer in excess of the compensation amount specified in IRC Section 414(q)(1)(B) ($130,000 for 2020 and 2021, $135,000 for 2022, and $150,000 for 2023), and, (2) if elected by the employer, also was in the top-paid group of employees (determined by reference to Section 414(q)(3)) for such preceding plan year (or for the current plan year in the case of the first year of employment).2

      Participation will be nondiscriminatory if the following requirements are satisfied:

      (1)     The plan benefits a classification of employees found by the Secretary of Treasury not to discriminate in favor of employees who are officers, shareholders, or highly compensated.

      (2)     No more than three years of employment are required for participation and the employment requirement for each employee is the same.

      (3)     Eligible employees begin participation by the first day of the first plan year after the employment requirement is satisfied.3

      Under the proposed regulations, a cafeteria plan does not discriminate in favor of highly compensated individuals if the plan benefits a group of employees who qualify under a reasonable classification established by the employer and the group of employees included in the classification satisfies the safe harbor percentage test or the unsafe harbor percentage test.4

      If a cafeteria plan offers health benefits, the plan is not discriminatory as to contributions and benefits if:

      (1)     contributions for each participant include an amount that either:

      (x)  equals 100 percent of the cost of the health benefit coverage under the plan of the majority of the highly compensated participants who are similarly situated (e.g., same family size); or

      (y)  equals or exceeds 75 percent of the cost of the most expensive health benefit coverage elected by any similarly-situated participant; and

      (2)     contributions or benefits in excess of (1) above bear a uniform relationship to compensation.5

      A plan is considered to satisfy all discrimination tests if it is maintained under a collective bargaining agreement between employee representatives and one or more employers.6

      Further, a “key employee,” as defined for purposes of the top-heavy rules, is treated as though he or she is in constructive receipt of the available cash benefit option in any plan year in which nontaxable benefits provided under the plan to key employees exceed 25 percent of the aggregate of such benefits provided to all employees under the plan. In making this calculation, excess group term life insurance coverage that is includable in income (see Q 8782 and Q 8783) is not considered a nontaxable benefit.7

      Employees of a controlled group of corporations, employers under common control, or members of an “affiliated service group” are treated as employed by a single employer.8

      Employer contributions include amounts that the employer contributes to a cafeteria plan pursuant to a salary reduction agreement to the extent that the agreement relates to compensation that has not been actually or constructively received by the employee as of the date of the agreement if such compensation does not subsequently become currently available to the employee.9

      See Q 8900 for the application of the nondiscrimination requirements to simple cafeteria plans.


      1.     IRC § 125(b)(1); Prop. Treas. Reg. § 1.125-7(m)(2).

      2.     IRC § 125(e); Prop. Treas. Reg. § 1.125-7(a)(3); Notice 2018-83, Notice 2019-59, Notice 2020-79, Notice 2021–61.

      3.     IRC § 125(g)(3); Prop. Treas. Reg. § 1.125-7(b).

      4.     Prop. Treas. Reg. § 1.125-7(b)(1).

      5.     IRC § 125(g)(2); Prop. Treas. Reg. § 1.125-7(e).

      6.     IRC § 125(g)(1).

      7.     IRC § 125(b)(2).

      8.     IRC § 125(g)(4).

      9.     Prop. Treas. Reg. § 1.125-1(r).

  • 8900. What is a simple cafeteria plan for small businesses?

    • A “simple cafeteria plan” is a cafeteria plan that is established and maintained by an eligible employer and with respect to which contribution, eligibility, and participation requirements are met.1For years beginning in 2011 and thereafter, the Patient Protection and Affordable Care Act (ACA) creates a safe harbor “simple cafeteria plan” under which an “eligible employer” (generally an employer with fewer than 100 employees) is treated as meeting any applicable nondiscrimination requirements (Q 8899) for the year.2

      The employer is required to make contributions on behalf of each “qualified employee” in an amount equal:

      (1)     a uniform percentage (not less than two percent) of the employee’s compensation; or

      (2)     an amount not less than the lesser of (x) six percent of the employee’s compensation for the plan year, or (y) twice the amount of salary deduction contributions of each qualified employee.3

      Contribution requirement option (2) is not met if the rate of contributions with respect to the salary contributions of any highly compensated or key employee at any rate of contribution is greater than that with respect to an employee who is not a highly compensated or key employee.4

      All employees with at least 1,000 hours of service during the preceding plan year must be eligible to participate. Further, each employee who is eligible to participate must be able to select any benefit available under the plan.5 An employee can be excluded if the employee:

      (1)     is under age 21;

      (2)     has less than one year of service;

      (3)     is covered by a collective bargaining agreement and the benefits of the cafeteria plan were the subject of good faith bargaining; or

      (4)     the employee is a nonresident alien working outside of the United States. 6

      To implement a simple cafeteria plan, an employer must be an “eligible employer,” which is, with respect to any year, any employer that employed an average of 100 or fewer employees on business days during either of the two preceding years.7 An employer that initially qualifies for a simple cafeteria plan ceases to qualify in the year after the number of employees reaches 200.8

      A qualified employee is any employee who is eligible to participate in the cafeteria plan and who is not a highly compensated or key employee.9


      1.     IRC § 125(j)(2); IRS Publication 15-B.

      2.     IRC § 125(j)(1).

      3.     IRC § 125(j)(3)(A).

      4.     IRC § 125(j)(3)(B).

      5.     IRC § 125(j)(4)(A).

      6.     IRC § 125(j)(4)(B).

      7.     IRC § 125(j)(5)(A).

      8.     IRC § 125(j)(5)(C).

      9.     IRC § 125(j)(3)(D).

  • 8901. What are the tax benefits that can be realized by providing employee benefits through a cafeteria plan?

    • As a general rule, a participant in a cafeteria plan is not treated as being in constructive receipt of taxable income solely because he or she has the opportunity – before a cash benefit becomes available – to elect among cash and “qualified” benefits (generally, nontaxable benefits).1A participant must elect the qualified benefits before the cash benefit becomes currently available in order to avoid taxation. That is, the election must be made before the specified period for which the benefit will be provided begins—generally, the plan year.2

      A cafeteria plan may, but is not required to, provide default elections for one or more qualified benefits for new employees or for current employees who fail to timely elect between permitted taxable and qualified benefits.3

      Benefits provided under a cafeteria plan through employer contributions to a health flexible spending arrangement (FSA) are not treated as qualified unless the plan provides that an employee may not elect to have salary reduction contributions in excess of $2,500 (this amount is indexed annually for inflation, see Q 8902) made to the FSA for any tax year.4 Under IRS Notice 2012-40:

      (1)     the $2,500 contribution limit did not apply for plan years that begin before 2013;

      (2)     the term “taxable year” in IRC Section 125(i) refers to the plan year of the cafeteria plan, as this is the period for which salary reduction elections are made;

      (3)     plans could adopt the required amendments to reflect the contribution limit at any time through the end of calendar year 2014;

      (4)     in the case of a plan providing a grace period (which may be up to two months and 15 days), unused salary reduction contributions to the health FSA for plan years beginning in 2012 or later that are carried over into the grace period for that plan year will not count against the contribution limit for the subsequent plan year; and

      (5)     unless a plan’s benefits are under examination by the IRS, relief is provided for certain salary reduction contributions exceeding the contribution limit that are due to a reasonable mistake and not willful neglect, and that are corrected by the employer.

      Under IRS Notice 2013-71, heath FSAs may now be amended so that $500 ($610 in 2023, $570 in 2022, $550 in 2020 and 2021) of unused amounts remaining at the end of the plan year may be carried forward to the next plan year. However, plans that incorporate the carry forward provision may not also offer the grace period that would otherwise allow FSA participants an additional period after the end of the plan year to exhaust account funds.5


      1.     IRC § 125; Prop. Treas. Reg. § 1.125-1.

      2.     Prop. Treas. Reg. § 1.125-2.

      3.     Prop. Treas. Reg. § 1.125-2(b).

      4.     IRC § 125(i).

      5.     Notice 2013-71, 2013-47 IRB 532.

  • 8902. What is a health flexible spending arrangement (FSA)?

    • Editor’s Note: The Affordable Care Act (“ACA”) imposes an annual limitation on contributions to a health FSA. For taxable years beginning after 2012, FSA contributions will not be treated as a qualified benefit unless the cafeteria plan provides that an employee may not elect for any taxable year to have salary reduction contributions in excess of $2,500 made to the arrangement. The limit will be indexed for inflation ($3,050 in 2023, $2,850 in 2022, and $2,750 in 2020 and 2021).1A health flexible spending arrangement (FSA) is a program that is established under IRC Section 125 to provide for the reimbursement of certain expenses that have already been incurred. This benefit may be provided as a stand-alone plan or as part of a traditional cafeteria plan.

      Health coverage under an FSA is not required to be provided under commercial insurance plans, but the coverage that is provided must demonstrate the risk shifting and risk distribution characteristics of insurance. Reimbursements under a health FSA must be paid specifically to reimburse medical expenses that have been incurred previously.

      A health FSA cannot provide coverage only for periods during which the participants expect to incur medical expenses if the period is shorter than a plan year. Further, the maximum reimbursement amount must always be available throughout the period of coverage (properly reduced for prior reimbursements for the same period of coverage).

      This must be true without regard to the extent to which the participant has paid the required premiums for the coverage period, and without a premium payment schedule based on the rate or amount of covered claims incurred in the coverage period.2 Though there was no statutory limit on contributions to a health FSA prior to 2013, most employers imposed a limit to protect themselves against large claims that had not yet been funded by salary reductions.

      The period of coverage must be 12 months, or in the case of a short first plan year, the entire first year (or the short plan year where the plan year is changed). Elections to increase or decrease coverage may not be made during a coverage year, but prospective changes may be allowed consistent with certain changes in family status.

      The plan may permit the period of coverage to be terminated if the employee fails to pay premiums, provided that the terms of the plan prohibit the employee from making a new election during the remaining period of coverage. The plan may permit revocation of existing elections by an employee who terminated service.3

      As is the case with a cafeteria plan, a health FSA may provide a grace period of no more than 2½ months following the end of the plan year for participants to incur and submit expenses for reimbursement. The grace period must apply to all participants in the plan. Plans may adopt a grace period for the current plan year by amending the plan document before the end of the current plan year.4

      For tax years beginning in 2014 and beyond, a health FSA may be amended so that $500 ($610 in 2023, $570 in 2022, and $550 in 2020 and 2021) of unused amounts remaining at the end of the plan year may be carried forward to the next plan year.  However, plans that incorporate the carry forward provision may not also offer the grace period.5

      The plan may not reimburse premiums paid for other health plan coverage, but it may reimburse medical expenses of the kind described under IRC Section 213(d).6 Beginning in 2011, reimbursements for medicine are limited to doctor-prescribed drugs and insulin. Before 2020, over-the-counter medicines were not qualified expenses unless the participant obtained a doctor’s prescription.7 However, beginning in 2020 the CARES Act now allows these over-the-counter medical expenses to be reimbursed by an FSA without a prescription.8

      The reimbursed medical expenses must be expenses incurred to obtain medical care during the period of coverage. The employee must provide substantiation that the expense claimed has been incurred and is not reimbursable under other health coverage.9 The IRS has approved the use of employer-issued debit and credit cards to pay for medical expenses as incurred, provided that the employer requires subsequent substantiation of the expenses or has in place sufficient procedures to substantiate the payments at the time of purchase.10 On a one-time basis, a plan may allow a qualified HSA distribution (see Q 8834).

      An employee must include the value of employer-provided coverage for qualified long-term care services provided through an FSA in gross income.11


      1.     IRC § 125(i), as added by PPACA 2010; Notice 2012-40, 2012-1 CB 1046.

      2.     Prop. Treas. Reg. § 1.125-5(d).

      3.     Prop. Treas. Reg. § 1.125-5(e).

      4.     Prop. Treas. Reg. § 1.125-1(e); Notice 2005-42, 2005-1 CB 1204; Notice 2012-40, 2012-1 CB 1046.

      5.     Notice 2013-71, 2013-47 IRB 532.

      6.     Prop. Treas. Reg. § 1.125-5(k).

      7.     IRC § 106(f).

      8.     CARES Act § 3702.

      9.     Prop. Treas. Reg. § 1.125-6(b); Rev. Proc. 2003-43, 2003-1 CB 935; superseded and modified by Notice 2013-30, 2013-21 IRB 1099. See Grande v. Allison Engine Co., 2000 U.S Dist. LEXIS 12220 (S.D. Ind. 2000).

      10.   Notice 2006-69, 2006-2 CB 107. See also Notice 2007-2, 2007-1 CB 254.

      11.   IRC § 106(c)(1).

  • 8903. What is a dependent care flexible spending arrangement (FSA)?

    • Editor’s Note: The dependent care FSA rules were relaxed in response to the COVID-19 pandemic. Typically, a dependent care flexible spending account (FSA) can be used to cover childcare for children under age 13. Under the year-end Consolidated Appropriations Act (CAA) of 2021, employers could amend dependent care FSAs to allow participants who have a qualifying child turning age 13 to continue to receive reimbursements for the child’s dependent care expenses for the remainder of the plan year and, with respect to any remaining balance, the next plan year up until the child turns 14. This is true if the child turned age 13 during a plan year with a regular enrollment period on or before January 31, 2020 (i.e., the 2020 year for calendar-year plans).Further, the CAA temporarily allowed dependent care FSAs to be amended to allow participants to carry over unused amounts in the participant’s account from 2020 to 2021, and from 2021 to 2022, without limit. Dependent care FSAs could allow prospective election changes for the plan year ending in 2021, regardless of whether a permitted election change event occurred.


      Planning Point: IRS Notice 2021-26 clarified that participants could take advantage of both (1) tax-free reimbursements of contributions made during the 2021 plan year up to the maximum $10,500 limit and (2) tax-free reimbursements of amounts carried over from the prior year. In other words, a participant with a $5,000 carryover amount from 2020 and a $10,500 contribution in 2021 could take tax-free distributions up to $15,500 in 2021 if that participant incurred enough qualifying expenses during the 2021 plan year.


      A dependent care flexible spending arrangement (FSA) is a program that is established under IRC Section 125 to provide for the reimbursement of certain expenses related to dependent care that have already been incurred. This benefit may be provided as a stand-alone plan or as part of a traditional cafeteria plan.

      Substantially the same rules apply to dependent care FSAs as health FSAs (see Q 8902), except that the maximum amount of reimbursement need not be available throughout the entire period of coverage. A plan may limit a participant’s reimbursement to amounts that were actually contributed to the plan and that are still available in the participant’s account.1 Contributions to a dependent care FSA may not exceed $5,000 (or $2,500 for a married individual filing a separate return) during a taxable year.2


      Planning Point: The ARPA doubled the annual limit under IRC Section 129 from $5,000 per year to $10,500 in 2021 ($5,250 for taxpayers who are married and file separate returns). Employers could amend their plans retroactively through the end of 2021 in order to provide for the increased limit.


      Like a health FSA, a dependent care FSA may permit a grace period of no more than 2½ months following the end of the plan year for participants to incur and submit expenses for reimbursement.3 A dependent care FSA may not, however, permit the same $500 carryfoward option that is now permitted in the context of health FSAs (but see Editor’s Note, above).

      The IRS has also approved the use of employer-issued debit and credit cards to reimburse for recurring dependent care expenses. Because expenses may not be reimbursed until the dependent care services are provided, reimbursements through debit cards must flow in arrears of expenses incurred.4


      1.     Prop. Treas. Reg. § 1.125-5.

      2.     IRC § 129(a)(2)(A); Notice 2012-40, 2012-1 CB 1046.

      3.     Notice 2005-42, 2005-1 CB 1204; Notice 2012-40, 2012-1 CB 1046.

      4.     Notice 2006-69, 2006-2 CB 107.

  • 8904. Is a surviving spouse of an employee taxed on the value of death benefits paid under a plan of the employer?

    • A surviving spouse who receives death benefits payable under a contract, or pursuant to an established plan of the employer, must include such amounts in income.1 However, if the employee death benefits are payable because of the death of certain terrorist attack victims or astronauts, they may be excluded from gross income.2Frequently, death benefits are funded by insurance on the life of the employee, with the insurance owned by and payable to the employer. These death benefits do not become tax-exempt to the employee’s surviving spouse simply because the proceeds of the insurance policy are received tax-free by the employer. While the employer receives the proceeds as life insurance proceeds, the surviving spouse receives them as compensation payments from the employer.3 As a result, employee death benefits rarely qualify as life insurance benefits wholly excludable under IRC Section 101(a).4 Death benefits payable to an employee’s surviving spouse under a split-dollar arrangement, however, may be received free of income tax obligations.

      Contractual death benefits are treated as “income in respect of a decedent.”5 As a result, where an estate tax has been paid, the recipient of the death payments is entitled to an income tax deduction for that portion of the estate tax attributable to the value of the payments.


      1.     Simpson v. U.S., 261 F.2d 497 (7th Cir. 1958); Robinson v. Comm., 42 TC 403 (1964).

      2.     IRC § 101(i).

      3.     Essenfeld v. Comm., 311 F.2d 208 (2d Cir. 1962).

      4.     See Edgar v. Comm., TC Memo 1979-524.

      5.     Est. of Wright v. Comm., 336 F.2d 121 (2d Cir. 1964).

  • 8905. What types of benefits can an employer provide in the form of services that do not require an employee to include the value of the benefit in income?

    • Generally, fringe benefits not expressly excluded from income by the Code must be included in gross income for income tax purposes and in wages for purposes of FICA and FUTA.1 IRC Section 132 provides that certain fringe benefits that are classified as “no-additional-cost-services” may be excluded from income.2As the name suggests, a “no-additional-cost-service” is one offered by the employer (1) at no substantial additional cost (including foregone revenue) to the employer for providing such service to the employee when (2) such service is offered to customers in the ordinary course of the line of business of the employer in which the employee is working.

      For example, the cost of a flight provided to an airline employee traveling on a space-available basis is an excess capacity service and is eligible for treatment as a no-additional-cost-service. In addition, the services of a flight attendant and the cost of in-flight meals given to the airline employee traveling on a space-available basis are merely incidental to the services being provided (i.e. the flight) and, thus, the employee does not have to include them in income.3 Reciprocity is allowed between unrelated employers if certain conditions are met.4

      The no-additional-cost services exclusion applies to services provided to retired and disabled employees, spouses and dependent children, as well as to current employees. Widowers and widows of employees who died while employed also qualify for the exclusion.5 A partner who performs services for a partnership will be considered employed by the partnership.6

      The no-additional-cost services exclusion is not available to highly compensated employees unless the service is provided on substantially the same terms to each member of a group of employees which is defined under a reasonable classification set up by the employer which does not discriminate in favor of highly compensated employees.7 For this purpose, “highly compensated employee” has the same meaning as provided in IRC Section 414(q) for qualified plans.8 Generally, a highly compensated employee is any employee:

      (1)     who was a five percent owner at any time during the year or the preceding year; or

      (2)     for the preceding year had compensation in excess of $130,000, as indexed for inflation in 2020 and 2021 ($135,000 for 2022) and was in the top-paid group of employees for the preceding year.


      1.     IRC § 61(a)(1).

      2.     IRC § 132.

      3.     Treas. Reg. § 1.132-2(a)(5).

      4.     See Treas. Reg. § 1.132-2(b).

      5.     IRC § 132(h).

      6.     Treas. Reg. § 1.132-1(b).

      7.     IRC § 132(j)(1).

      8.     IRC § 132(j)(6).

  • 8906. What types of tax-preferred transportation-related fringe benefits can an employer provide to its employees?

    • Editor’s Note: The 2017 tax reform legislation eliminated certain deductions for expenses associated with providing any qualified transportation fringe to employees, and except for ensuring employee safety, any expense incurred for providing transportation (or any payment or reimbursement) for commuting between the employee’s residence and place of employment. Employees can continue to pay for mass transit and parking benefits using pre-tax dollars through employer-sponsored salary reduction programs. These rules are effective for tax years beginning after December 31, 2017.1 The rules discussed below generally apply to tax years beginning before 2018 unless otherwise noted. See Q 8907 for more information on the calculation of employer-sponsored parking benefits post-tax reform.The 2017 tax reform legislation also eliminated the ability of taxpayers to exclude qualified bicycle commuting expense reimbursements from gross income and wages from December 31, 2017 to January 1, 2026. However, employers are permitted to provide qualified bicycle commuting benefits and deduct the expenses as ordinary and necessary business expenses.2


      Planning Point: The IRS released guidance providing that employers cannot use a salary reduction plan in order to provide deductible commuting benefits for employees in 2018-2025. As a result of the new rules (discussed above), some employers had considered setting up salary reduction plans in order to deduct the amounts as salary, while the employee could use the funds to pay for parking or transit benefits. The IRS updated Publication 15-B, which now specifically provides that commuting benefits provided through salary reduction, or through a bona fide reimbursement arrangement, are not deductible by the employer.


      Prior to the tax reform legislation’s passage, Congress placed mass transit benefits on par with employer-provided parking expenses, so that a taxpayer could exclude up to $250 a month in employer-provided transportation in a commuter vehicle or employer-provided transit passes. Congress retroactively extended this parity for the 2015 tax year. The Protecting Americans Against Tax Hikes Act of 2015 (PATH) made these provisions “permanent.”

      A “qualified transportation fringe” is a benefit provided by an employer to employees, and includes:

      (1)     transportation in a commuter highway vehicle that is used in connection with travel between an employee’s home and place of work;

      (2)     any transit pass; or

      (3)     qualified parking.3

      A cash reimbursement from an employer to an employee for one of these items also falls within the qualified transportation fringe definition if the transit passes are not readily available in the employer’s area.4 A transit pass may still be readily available if the transportation provider only accepts a certain form of payment (i.e., the transportation provider only accepts cash or checks, and the employer has provided a debit card to pay for transit expenses). The IRS has indicated that payment restrictions, unless combined with other restrictions, are not sufficient to cause a transit pass to fail to be readily available.5


      Planning Point: The 2017 tax reform legislation created a provision that will cause tax-exempt entities that provide certain employee fringe benefits to become subject to the unrelated business income tax (UBIT, essentially, the corporate tax rate (21 percent) applied to the value of the fringe benefits provided). The UBIT generally applies to income derived from activities that are not substantially related to the tax-exempt purpose of the organization. The UBIT issue will come into play for tax-exempt entities that provide qualified transportation fringe benefits (including transit passes), or access to on-site athletic facilities (i.e., a gym) after December 31, 2017.6 As a result, tax-exempt entities that currently provide these fringe benefits should consider restructuring their practices in order to ensure that the UBIT issue is avoided (for example, by increasing employees’ pay to allow them to purchase the benefits). A provision that would have applied the UBIT to certain parking facilities was repealed.


      Self-employed individuals and owner-employees are not considered employees for purposes of qualified transportation fringes.7

      Code Section 132 places a limit on the amount that may be excluded from income for a qualified transportation fringe. These limitation amounts are adjusted for inflation.8

      An employee could exclude up to $250 per month in (combined) employer-provided transportation in a commuter vehicle or for transit passes. An employee may exclude $250 per month for qualified parking expenses.9 The limits are indexed for inflation annually ($300 in 2023, $280 in 2022).

      For purposes of Section 132, a “commuter highway vehicle” is defined as any highway vehicle that seats at least six persons and which is used at least 80 percent of the time for transporting employees between their homes and places of work.10

      A “transit pass” is any pass, token, fare card, voucher or similar item which entitles an individual to transportation on mass transit facilities or in commuter highway vehicles.11

      “Qualified parking” is defined as parking provided to an employee on or near the employer’s business location or near a location from which an employee commutes to work by mass transit, commuter highway vehicle, or carpool. It does not include any parking near the employer’s place of business that the employee uses for residential parking.12


      Planning Point: Some major cities are considering their own commuter benefit laws.  For example, it’s expected that Philadelphia employers with 50 or more covered employees will be required to offer a pre-tax payroll deduction for certain mass transit expenses, qualified bicycle expenses or employer-covered benefits for fare instruments beginning December 31, 2022.


      The IRS released a program manager technical assistance providing guidance for employers that chose to make cash reimbursements to employees to compensate them for retroactive increases in the amount of transit benefits that may be excluded from income under IRC Section 132(f). Many employers wished to reimburse employees to account for the increased permissible benefit level in past years. Typically, cash payments made by employers for transit benefits are only excludable from an employee’s income if transit passes are not readily available in the employer’s area. The IRS has indicated that cash amounts that exceed the monthly maximum limit (in any month) will be taxed as wages, even if those amounts are paid because of the retroactive increase in the monthly amount for past years.13


      Planning Point: An IRS information letter clarified that a taxpayer forfeits any unused transportation benefits upon termination of employment. Because employers are only permitted to provide tax-preferred transportation benefits to current employees, those benefits must be lost once the individual is no longer an employee. This is the case even if the benefits were provided through pre-tax employee contributions, and even if the employee is fired (i.e., compensation reductions cannot be reimbursed if the employee had not fully used them). Importantly, employees can change their elections regarding transportation benefits monthly without the need for a change in status event.14


      Planning Point: With so many employees working from home for the bulk of 2020, many employees questioned whether they would lose their unused qualified transportation benefits. Some employees opted to drive rather than use public transit–and others did not commute at all. The IRS released an information letter15 explaining that unused qualified transportation benefit amounts could be rolled over to subsequent periods and used for future commuting expenses. To qualify, the employee must have made a valid compensation reduction election and remain employed by the employer in the subsequent period. Further, the IRS confirmed that unused amounts could be applied to other types of qualified transportation benefits, including parking, if the employer offers that benefit. On the other hand, the IRS noted that refunds of unused qualified transportation benefits are not permitted if those benefits are provided through a compensation reduction agreement. Employers may wish to revisit the terms of their transportation benefit plan to ensure employees can take advantage of this flexibility.



      1.     IRC § 274(a)(4).

      2.     IRC §§ 132(f)(8), 274(l).

      3.     IRC § 132(f)(1).

      4.     IRC § 132(f)(3).

      5.     IRS INFO 2016-0007.

      6.     IRC § 512(a)(7).

      7.     IRC § 132(f)(5)(E).

      8.     IRC § 132(f)(6).

      9.     IRC § 132(f)(2), IRS Publication 15-B.

      10.   IRC § 132(f)(5)(B).

      11.   IRC § 132(f)(5)(A).

      12.   IRC § 132(f)(5)(C).

      13.   PMTA 2016-001.

      14.   IRS INFO 2019-002.

      15.   IRS INFO 2020-0024.

  • 8907. How can an employer calculate the value of parking benefits that it provides to employees after enactment of the 2017 tax reform legislation?

    • Late in 2018, the IRS released guidance on how to calculate the value of parking benefits provided to employees after the 2017 tax reform legislation restricted the deductibility of these benefits. The 2020 proposed regulations expanded upon this guidance and provided rules for calculating amounts that may be deductible. Under Notice 2018-99, employers were permitted to take steps by March 31, 2019 to retroactively change their parking arrangements to reduce or eliminate the number of parking spaces reserved for employees.Under the new guidance, employers can use any reasonable interpretation for determining the amount in question, but fair market value of the parking provided to employees does not constitute a reasonable method because the deduction is related to the expense of providing the benefit, not its value.

      Determining the relevant amount will depend on whether the employer pays a third party for the parking spaces, or whether the employer owns or leases all or a portion of a parking facility. If the employer pays a third party, the amount that is paid will constitute the total annual cost of employee parking.1 If that amount exceeds the Section 132(f) limitation ($280 in 2022, up from $270 in 2020), the amounts paid above that limit are taxable compensation to the employee. Amounts treated as taxable compensation are deductible by the employer.

      If the employer owns or leases the parking facility, the proposed regulations provide a general rule and three simplified methods for calculating the amount of nondeductible expenses. Taxpayers may elect to apply the general rule or a simplified methodology for each taxable year and for each parking facility.

      The general rule provides that employers can use a reasonable interpretation for calculating the disallowance under Section 274, but that employers must (1) use expenses that are paid or incurred in providing the parking benefit, rather than its value to employees, (2) allocate parking expenses to spaces reserved for employees, and (3) properly apply the exception for parking made available to the general public.2

      Under the first simplified method, the “qualified parking limit method,” taxpayers calculate the disallowance by multiplying the total number of spaces used by employees during the peak demand period, or, alternatively, the total number of the taxpayer’s employees, by the Section 132(f)(2) monthly per-employee limit on exclusion for qualified parking, for each month in the tax year.3

      The primary use method is based on the guidance provided in Notice 2018-99. It contains a four-step process that requires the employer to (1) calculate the disallowance for reserved employee spaces, (2) determine the primary use of available parking spaces, (3) calculate the allowance for reserved non-employee spaces and (4) determine the remaining use of available parking spaces and allocable expenses. Note that there is no disallowance for reserved employee spaces if the primary use of the available parking spaces is to provide parking to the general public, and there are five or fewer reserved employee spaces in the parking facility and the reserved employee spaces are 5 percent or less of the total parking spaces. The regulations modify the definition of “general public” to exclude employees, partners, 2 percent shareholders of S-corporations, sole proprietors, independent contractors, clients, or customers of unrelated tenants in multi-tenant buildings (among other individuals).4

      The third simplified method is the “cost per space method”. This method allows taxpayers to calculate the disallowance by multiplying the cost per parking space by the number of available parking spaces to be used by employees during the peak demand period. Cost per space is calculated by dividing total parking expenses (including expenses for inventory/unusable spaces) by total parking spaces (including inventory/unusable spaces). Special rules for allocating certain mixed parking expenses and aggregating parking spaces by geographic location may be used with the cost per space method.5

      Note that parking expenses include all of the costs of taking care of the facility—i.e., repairs, maintenance, utilities, insurance, property taxes, snow/leaf/trash removal, cleaning, costs of employing parking attendants, as well as any actual costs for leasing or renting the space. Depreciation is not included. The expenses must then be allocated between those spaces reserved for employee parking, spaces reserved for the general public and spaces that can be used by either employees or the public.

      The percentage of costs allocated to employee parking is no longer deductible, and the costs allocated to public parking are deductible as business expenses.

      With respect to “non-reserved” spaces, the employer must determine their primary use. If the spaces are used more than 50 percent of the time by employees during business hours, the deduction is.6


      1.     Prop. Treas. Reg. § 1.274-13(d)(1).

      2.     Prop. Treas. Reg. § 1.274-13(d)(2)(i).

      3.     Prop. Treas. Reg. § 1.274-13(d)(2)(ii)(A).

      4.     Prop. Treas. Reg. §§ 1.274-13(d)(2)(ii)(B), 1.274-13(b)(3).

      5.     Prop. Treas. Reg. § 1.274-13(d)(2)(ii)(C).

      6.     Notice 2018-99.

  • 8908. Can an employee exclude from income the value of employee discounts offered by the employer?

    • The “qualified employee discount” exclusion applies to employee discounts provided by the employer on any property (other than real property or personal property of a kind held for investment) or services which are offered for sale to customers in the ordinary course of the line of business of the employer for which the employee works. For the benefit to be excludable from income, the discount may not exceed:

      (1)     the gross profit percentage of the price at which the property is being offered by the employer to customers in the case of property; or

      (2)     20 percent of the price at which services are offered by the employer to customers, in the case of services.1

      For purposes of this provision, an insurance policy or a commission or similar fee charged by a brokerage house or an underwriter on sales of securities is considered a service.2 The qualified employee discount will generally be available for employees of leased sections of department stores.3 The same nondiscrimination rules apply to qualified employee discounts as apply to no-additional-cost services (see Q 8905).4


      1.     IRC § 132(c).

      2.     Treas. Reg. § 1.132-2(a)(2).

      3.     IRC § 132(j)(2).

      4.     IRC § 132(j)(1).

  • 8909. What is a “working condition” fringe benefit?

    • A “working condition fringe” benefit is defined as property or services provided by the employer to the extent that, if the employee paid for such property or services, he or she would be able to deduct the expenses as a business expense prior to 2018.1For example, qualified automobile demonstration is considered to be a working condition fringe benefit and is defined as the use of an auto by a full-time auto salesman in the area where the dealer’s sales office is located provided that the auto is used to aid the salesman in his job and personal use is substantially restricted.2 The IRS has ruled that tax preparation services provided by an employer to employees stationed in foreign countries as a part of a tax equalization program were not excludable fringe benefits because the employees would be unable to deduct the expenses if they had paid for them themselves. Further, the IRS found that the fair market value (determined as though the employees had paid for the services in an arm’s length transaction) was both includable in income and treated as wages for employment tax purposes.3


      Planning Point: Employers should be particularly conscious of low-value fringe benefits around the holidays. Employers are required to treat “gifts” as wages–meaning that federal withholding and tax withholding requirements will apply. Failure to comply can result in penalties. In order to avoid these requirements, the gift will have to qualify as a fringe benefit. Importantly, “gifts” of cash or cash equivalents can never qualify as fringe benefits. Therefore, things like gift cards must be treated in the exact same way as wages—even if the dollar value is relatively low. Other types of gifts that have a relatively low value can be excluded from income. The gift, however, must be so small that accounting for the value would be impractical or unreasonable. There is no set dollar limit that qualifies as “de minimis” in the eyes of the IRS—but it is generally thought that even infrequent gifts that are valued at more than $100 will not qualify.


      This exclusion is generally available to any current employee, any partner who performs services for the partnership, any director of the employer, and any independent contractor who performs services for the employer.4 There is no nondiscrimination requirement.


      1.     IRC § 132(d).

      2.     IRC § 132(j)(3).

      3.     ILM 201810007.

      4.     Treas. Reg. § 1.132-1(b)(2).

  • 8910. What is a “de minimis” fringe benefit?

    • Editor’s Note: The 2017 tax reform legislation eliminated the 50 percent deduction for business-related entertainment expenses. Although the 50 percent deduction for meal expenses generally remains in effect (including meals consumed while travelling for business), Congress lifted the 50 percent cap for 2021 and 2022. The 2017 tax reform legislation also expanded the deduction for meals to include expenses associated with meals provided through an eating facility meeting the de minimis fringe benefit requirements discussed below.1 This deduction for meals provided at the convenience of the employer expires after December 31, 2025.2The “de minimis fringe” exception allows an employee to exclude from income any property or services provided by the employer, if the value of such property or services is so small as to make accounting for it unreasonable or administratively impractical.3

      For example, an employer-operated eating facility is considered a de minimis fringe if it is located on or near the business premises and the revenue from the facility equals or exceeds its operating costs. These rules are applicable to highly-compensated employees only if access to the facility is available on substantially the same terms to each member of a group of employees which is defined under a reasonable classification set up by the employer which does not discriminate in favor of highly compensated employees (see Q 8905).4

      The IRS provided specific guidance with respect to meals provided for the convenience of the employer. The IRS has released a technical advice memorandum (TAM) that sheds light on the potential tax implications when employers provide employees with free meals in the office. Post-tax reform, meals provided “for the convenience of the employer” may receive favorable tax treatment. In the TAM, the IRS denied exclusion of the meals’ value from employee compensation. Here, the employer provided free meals to all employees in snack areas, at their desks and in the cafeteria, justifying provision of these meals by citing need for a secure business environment for confidential discussions, employee protection, improvement of employee health and a shortened meal period policy. The IRS rejected these rationales, stating that the employer was required to show that the policies existed in practice, not just in form, and that they were enforced upon specific employees. In this case, the employer had no policies relating to employee discussion of confidential information and provided no factual support for its other claims. General goals of improving employee health were found to be insufficient. The IRS also considered the availability of meal delivery services a factor in denying the exclusion, but indicated that if the employees were provided meals because they had to remain on the premises to respond to emergencies, that would be a factor indicating that the exclusion should be granted.5


      Planning Point: Early in 2021, the EEOC released a set of regulations to govern whether employers could permissibly offer certain wellness incentives to employees. Those rules were designed to replace regulations that were vacated by court order in 2018. Under the new regulations, employers would have been permitted to offer certain de minimis incentives to employees who participated in wellness programs, including low value gift cards and other “gifts”. However, employers who also offered a health insurance plan in conjunction with the wellness program would have been permitted to offer incentives valued at up to 30 percent of the cost of coverage.

      Importantly, the regulations would have offered guidance for employers interested in offering nontaxable incentives to employees who received the COVID-19 vaccine. Those employers should now exercise caution when using incentives to encourage the vaccine. For example, they should be aware of the need to offer reasonable accommodation for religious beliefs or disability (in other words, they may need to provide an alternative way to earn the incentive for employees who will not get the vaccine because of religious beliefs or disability). Employers should also consider the 30 percent limit when determining whether to impose a health insurance surcharge for employees who elect to remain unvaccinated—as well as the ACA limits on affordability that apply to large employers.


      The frequency with which the employer provides the benefit at issue must be taken into account in determining whether the value is de minimis. The benefits provided must be calculated on a per-employee basis. For example, if an employer provides one meal to only one employee on a daily basis, the value of the free daily meal would not be de minimis to that individual employee, even though the provision of one daily meal to one employee would be de minimis with respect to the employer’s entire workforce.6

      If, however, it would be administratively difficult to determine the frequency with which the employer provides the fringe benefit to an individual employee, the employer may measure frequency based on the frequency for the provision of the fringe benefit to all employees. The regulations use the example of an employer who uses reasonable means to restrict use of employer-provided copy machines to business-related use and is successful in ensuring that 85 percent of the copying is for business use. Any personal use of the copy machine by a particular employee will be considered a de minimis fringe because it would be administratively difficult for the employer to measure usage on a per-employee basis.7

      An employer may provide meals, money for meals or local transportation fare as de minimis benefits if the following conditions are satisfied:

      (1)     The benefit is provided on an occasional basis, determined by examining the availability of the benefit and the regularity with which the benefit is provided to the employee. If an employer provides one of these benefits, or a combination of the three benefits, on a regular or routine basis, they are not provided on an occasional basis.

      (2)     The benefit is provided because of overtime work that requires an extension of the employee’s work schedule, even if the conditions giving rise to the need for overtime are reasonably foreseeable.

      (3)     In the case of a meal or meal money, the benefit is provided to enable the employee to work overtime hours.

      Meal money and local transportation fare will not qualify as de minimis benefits if the amounts provided are calculated based on the number of hours that the employee works.8


      1.     IRC § 274(n).

      2.     IRC § 274(o).

      3.     IRC § 132(e)(1).

      4.     IRC § 132(e)(2).

      5.     TAM 201903017.

      6.     Treas. Reg. § 1.132-6(b)(1).

      7.     Treas. Reg. § 1.132-6(b)(2).

      8.     Treas. Reg. § 1.132-6(d)(2).

  • 8911. How is the value of a fringe benefit that is not excludable under IRC Section 132 determined for purposes of determining the amount that must be included in the employee’s income?

    • A fringe benefit not excludable under the rules discussed in Q 8905 to Q 8910 (no-additional-cost, transportation, employee discount and de minimis fringe benefits) is included in the gross income of the employee to the extent that the fair market value of the benefit exceeds the sum of (a) the amount, if any, paid by the employee for the benefit and (b) the amount, if any, specifically excluded by some other section of the IRC.1Therefore, if the employee pays fair market value for the benefit, no amount must be included in gross income.2

      The fair market value of a fringe benefit is determined on the basis of objective facts and circumstances. The amount that an individual would have to pay for the fringe benefit in an arm’s length transaction is considered in determining the fair market value.3 The regulations specifically provide that in calculating fair market value, any special relationship that exists between the employer and employee must be disregarded.4

      Special optional rules are available for determining the fair market value of employer-provided automobiles. Specifically, the fair market value is based on the amount that the employee would be required to pay in order to lease the same or comparable vehicle, under comparable conditions (for example, taking use restrictions into consideration) in an arm’s length transaction in the same geographic area.5


      1.     Treas. Reg. § 1.61-21(b)(1).

      2.     Treas. Reg. § 1.61-21(b)(1).

      3.     Treas. Reg. § 1.61-21(b)(2).

      4.     Treas. Reg. § 1.61-21(b)(2).

      5.     Treas. Reg. § 1.61-21(b)(4).

  • 8912. How did the 2017 tax reforms impact the treatment of length of service awards for bona fide volunteers?

    • The 2017 tax reform legislation increased the aggregate amount of length of service awards that may accrue for a bona fide volunteer with respect to any year of service to $6,000 (from $3,000) for tax years beginning after December 31, 2017.1 The $6,000 amount will be adjusted for inflation in $500 increments.

      1.     IRC § 457(e)(11)(B).

  • 8913. How did the 2017 tax reforms impact the treatment of employee achievement awards?

    • Generally, certain employee achievement awards granted by an employer to recognize the employee’s length of service or safety achievements are not taxable to the employee and are deductible by the employer. Under the 2017 tax reform legislation, certain awards are excluded from this treatment, including cash, cash equivalents, gift certificates, vacations, meals, lodging, tickets to sports or theater events, stocks, bonds, securities and other similar items.1This essentially means that employee achievement awards must be received in the form of tangible personal property in order to receive favorable tax treatment. These provisions are effective for tax years beginning after December 31, 2017.


      1.     IRC §§ 74, 274(j)(3).

  • 8916. Can an employer provide employee fringe benefits through a stock bonus plan?

    • Yes, an employer can provide employees with benefits through a stock bonus plan. Generally, a stock bonus plan is a profit sharing plan that holds employer securities and generally distributes those securities to participants when benefits are paid.1Stock bonus plans can be funded through an employer’s contribution of employer securities, cash, or both. Traditionally, the IRS has taken the position that the distribution must be in the form of employer stock (except for the value of a fractional share).2 The Tax Court has agreed with the IRS position.3 A stock bonus plan may provide for payment of benefits in cash if certain conditions are met (see Q 8917). For the purpose of allocating contributions and distributing benefits, the plan is subject to the same requirements as a profit sharing plan.


      1.     Treas. Reg. § 1.401-1(a)(2)(iii).

      2.     Rev. Rul. 71-256, 1971-1 CB 118.

      3.     Miller v. Comm., 76 TC 433 (1981).

  • 8917. What special requirements apply to a stock bonus plan offered by an employer?

    • In addition to meeting all of the requirements of IRC Section 401(a) and the requirements outlined below, employee stock bonus plans must meet certain distribution (Q 8918) and voting (Q 8919) requirements as to employer stock that is held by the plan.1If the employer securities held within the plan are not readily traded on a public market, any transactions involving stock require an independent valuation of the stock for that transaction. A stock bonus plan generally is required to give participants the right to demand benefits in the form of employer securities. If employer securities are not readily tradable on an established market, the participant must be given the right to require the employer (not the plan) to repurchase employer securities under a fair valuation formula (a “put option”).2

      The requirement that participants have the right to demand benefits in the form of employer securities does not apply in situations where the charter or bylaws of the employer restrict the ownership of substantially all outstanding employer securities to employees, to a qualified plan trust, or to an S corporation.3

      The employer must make this put option available for at least 60 days following distribution of the stock and, if it is not exercised within that time, it must be made available for another 60 day period (at a minimum) in the following year.4

      The plan may repurchase the stock instead of the employer, but the plan cannot be required to do so. Certain banks that are prohibited by law from redeeming or purchasing their own shares are not subject to the requirement that they give participants a put option.5

      If, pursuant to a put option, an employer is required to repurchase securities distributed to an employee as part of a “total distribution,” the amount paid for the securities must be paid in substantially equal periodic payments (at least annually), over a period beginning within 30 days after the exercise of the put option, and not exceeding five years. The employer must provide adequate security and reasonable interest must be paid on any unpaid amounts. A total distribution is a distribution to the recipient within one taxable year of the balance to the credit in his or her account.6 If an employer is required to repurchase securities distributed to an employee as part of an “installment distribution,” the amount paid for the securities must be paid within 30 days after the put option is exercised.7


      1.     IRC §§ 401(a)(23), 4975(e)(7).

      2.     IRC § 409(h).

      3.     IRC § 409(h)(2)(B).

      4.     IRC § 409(h)(4).

      5.     IRC § 409(h)(3).

      6.     IRC § 409(h)(5).

      7.     IRC § 409(h)(6).

  • 8918. What rules govern distributions from an employer-sponsored stock bonus plan?

    • Distributions from a stock bonus plan are subject to mandatory 20 percent withholding, unless the employee elects a direct rollover.1 The mandatory withholding requirement does not apply to any distribution that consists only of securities of the employer-corporation and cash of up to $200 that is received in lieu of stock. The maximum amount to be withheld under the mandatory withholding rules may not exceed the sum of the amount of money received and the fair market value of property other than securities of the employer corporation received in the distribution.2The plan must provide that if a participant, with the consent of his or her spouse, so elects, the distribution of the account balance will begin within one year after the plan year:

      (1)     in which the participant separates from service by reason of attainment of the normal retirement age under the plan, disability, or death; or

      (2)     which is the fifth plan year following the plan year in which the participant otherwise separated from service.

      Distribution under (2) will not be required if the participant is re-employed by the employer before distributions actually begin under (2).3

      The plan also must provide that, unless the participant elects otherwise, distribution of the participant’s account balance will be made in substantially equal periodic payments (at least annually) over a period not longer than the greater of (1) five years, or (2) in the case of a participant with an account balance in excess of $1,330,000 as indexed in 2023 ($1,230,000 in 2022), five years plus one additional year (not to exceed five additional years) for each $265,000 (for 2023) ($245,000 for 2022), or fraction thereof, by which the employee’s account balance exceeds $1,330,000 ($1,230,000 in 2022).4


      Planning Point: An employer whose stock is not publicly traded, and therefore is subject to the employer’s potential obligation to repurchase its stock from terminating plan participants, should be concerned about the impact that obligation could have on its cash flow. The employer should consider writing its plan to take the maximum time allowed, generally five years, to begin the process of distributing stock from the plan and then repurchasing that stock from former employees. Martin Silfen, J.D., Brown Brothers Harriman Trust Co., LLC.


      Notwithstanding these requirements, if the general rules for commencement of distributions from qualified plans require distributions to begin at an earlier date, those general rules control.5


      1.     IRC § 3405(c).

      2.     IRC § 3405(e)(8).

      3.     IRC § 409(o)(1)(A).

      4.     IRC § 409(o)(1)(C); Notice 2018-83, Notice 2019-59.

      5.     See General Explanation of TRA ’86, p. 840.

  • 8919. Does participation in an employer’s stock bonus plan entitle the employee-participant to voting privileges?

    • A stock bonus plan is required to pass through certain voting rights to participants or beneficiaries. If an employer’s securities are “registration-type,” each participant or beneficiary generally must be entitled to direct the plan as to how securities allocated to him or her are to be voted.1 “Registration-type” securities are securities that must be registered under Section 12 of the Securities and Exchange Act of 1934 or that would be required to be registered except for an exemption in that law.2If securities are not “registration-type” and more than 10 percent of a plan’s assets are invested in securities of the employer, each participant (or beneficiary) must be permitted to direct voting rights under securities allocated to his or her account with respect to approval of corporate mergers, consolidations, recapitalizations, reclassifications, liquidations, dissolutions, sales of substantially all of the business’s assets, and similar transactions as provided in future regulations.3

      If the plan contains non-registration-type securities, the plan satisfies this requirement if each participant is given one vote with respect to an issue and the trustee votes the shares held by the plan in a proportion that takes this vote into account.4


      1.     IRC §§ 401(a)(28), 4975(e)(7), 409(e)(2).

      2.     IRC § 409(e)(4).

      3.     IRC § 409(e)(3).

      4.     IRC §§ 401(a)(22), 409(e)(3), 409(e)(5).