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Page 1 of 24 of Publication 15-B 8:29 - 26-JAN-2005

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ContentsDepartment of the TreasuryInternal Revenue Service What’s New . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

Publication 15-B 1. Fringe Benefit Overview . . . . . . . . . . . . . . . . . . . 2(Rev. January 2005) Are Fringe Benefits Taxable? . . . . . . . . . . . . . . . 2Cat. No. 29744N Cafeteria Plans . . . . . . . . . . . . . . . . . . . . . . . . . . 2

2. Fringe Benefit Exclusion Rules . . . . . . . . . . . . . 3Accident and Health Benefits . . . . . . . . . . . . . . . 5Employer’s Achievement Awards . . . . . . . . . . . . . . . . . . . . . 5Adoption Assistance . . . . . . . . . . . . . . . . . . . . . . 6Athletic Facilities . . . . . . . . . . . . . . . . . . . . . . . . . 6Tax Guide to De Minimis (Minimal) Benefits . . . . . . . . . . . . . . . 6Dependent Care Assistance . . . . . . . . . . . . . . . . 7Educational Assistance . . . . . . . . . . . . . . . . . . . 7Employee Discounts . . . . . . . . . . . . . . . . . . . . . . 8FringeEmployee Stock Options . . . . . . . . . . . . . . . . . . 8Group-Term Life Insurance Coverage . . . . . . . . . 9Lodging on Your Business Premises . . . . . . . . . 11BenefitsMeals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11Moving Expense Reimbursements . . . . . . . . . . . 13No-Additional-Cost Services . . . . . . . . . . . . . . . . 14For Benefits ProvidedRetirement Planning Services . . . . . . . . . . . . . . . 14in 2005 Transportation (Commuting) Benefits . . . . . . . . . 14Tuition Reduction . . . . . . . . . . . . . . . . . . . . . . . . 15Working Condition Benefits . . . . . . . . . . . . . . . . . 16

3. Fringe Benefit Valuation Rules . . . . . . . . . . . . . 17General Valuation Rule . . . . . . . . . . . . . . . . . . . 17Cents-Per-Mile Rule . . . . . . . . . . . . . . . . . . . . . . 18Commuting Rule . . . . . . . . . . . . . . . . . . . . . . . . . 18Lease Value Rule . . . . . . . . . . . . . . . . . . . . . . . . 19Unsafe Conditions Commuting Rule . . . . . . . . . . 21

4. Rules for Withholding, Depositing, andReporting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

How To Get Forms and Publications . . . . . . . . . . . 23

Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

What’s NewCents-per-mile rule. The standard mileage rate you canuse under the cents-per-mile rule to value the personal useof a vehicle you provide to an employee in 2005 is in-creased to 40.5 cents a mile. See Cents-Per-Mile Rule insection 3.

Employee stock options Section 251 of the AmericanJobs Creation Act of 2004 provides that wages for socialGet forms and other information security, Medicare, and federal unemployment taxes dofaster and easier by: not include remuneration from exercising an incentivestock option or an employee stock purchase plan optionInternet • www.irs.govafter October 22, 2004, or from any disposition of stock

FAX • 703–368–9694 (from your fax machine) acquired by exercising such an option. Federal income taxwithholding is not required on income from a disqualifyingdisposition of stock acquired by exercising an incentivestock option or an employee stock purchase plan option

TM

for Business after October 22, 2004, or on income from any dispositionwww.irs.gov/efile of stock acquired by exercising an employee stock

purchase plan option after October 22, 2004, equal to the

of 24 of Publication 15-B 8:29 - 26-JAN-2005


discount portion of stock acquired by exercising the option. services. That person may be the recipient even if theSee Employee Stock Options in section 2. benefit is provided to someone who did not perform serv-

ices for you. For example, your employee may be theIncrease in qualified parking exclusion and commuter recipient of a fringe benefit you provide to a member of thetransportation benefit. For 2005, the monthly exclusion employee’s family.for qualified parking increases to $200 and the monthlyexclusion for commuter highway vehicle transportation

Are Fringe Benefits Taxable?and transit passes increases to $105. See Qualified Trans-portation Benefits in section 2.

Any fringe benefit you provide is taxable and must beincluded in the recipient’s pay unless the law specificallyexcludes it. Section 2 discusses the exclusions that applyIntroduction to certain fringe benefits. Any benefit not excluded under

This publication supplements Publication 15, (Circular E), the rules discussed in section 2 is taxable.Employer’s Tax Guide, and Publication 15-A, Employer’sSupplemental Tax Guide. It contains specialized and de- Including taxable benefits in pay. You must include in atailed information on the employment tax treatment of recipient’s pay the amount by which the value of a fringefringe benefits. benefit is more than the sum of the following amounts.

Comments and Suggestions. We welcome your com- • Any amount the law excludes from pay.ments about this publication and your suggestions for • Any amount the recipient paid for the benefit.future editions. You can email us while visiting our websiteat www.irs.gov. You can write to us at the following ad- The rules used to determine the value of a fringe benefitdress: are discussed in section 3.

Internal Revenue ServiceIf the recipient of a taxable fringe benefit is your em-TE/GE Forms and Publications Branch

ployee, the benefit is subject to employment taxes andSE:W:CAR:MP:T:Tmust be reported on Form W-2, Wage and Tax Statement.1111 Constitution Ave. NW, IR-6406However, you can use special rules to withhold, deposit,Washington, DC 20224and report the employment taxes. These rules are dis-cussed in section 4.We respond to many letters by telephone. It would be

If the recipient of a taxable fringe benefit is not yourhelpful if you would include your daytime phone number,employee, the benefit is not subject to employment taxes.including the area code, in your correspondence.However, you may have to report the benefit on one of the

Photographs of missing children. The Internal Reve- following information returns.nue Service is a proud partner with the National Center forMissing and Exploited Children. Photographs of missing If the recipientchildren selected by the Center may appear in this publica- receives the benefit as: Use:tion on pages that would otherwise be blank. You can help

An independent contractor Form 1099-MISCbring these children home by looking at the photographsand calling 1-800-THE-LOST (1-800-843-5678) if you rec- A partner Schedule K-1 (Formognize a child. 1065)

For more information, see the instructions for the formslisted above.1. Fringe Benefit Overview

A fringe benefit is a form of pay for the performance of Cafeteria Plansservices. For example, you provide an employee with afringe benefit when you allow the employee to use a A cafeteria plan, including a flexible spending arrange-business vehicle to commute to and from work. ment, is a written plan that allows your employees to

choose between receiving cash or taxable benefits insteadPerformance of services. A person who performs serv-of certain qualified benefits for which the law provides anices for you does not have to be your employee. A personexclusion from wages. If an employee chooses to receive amay perform services for you as an independent contrac-qualified benefit under the plan, the fact that the employeetor, partner, or director. Also, for fringe benefit purposes,could have received cash or a taxable benefit instead willtreat a person who agrees not to perform services (such asnot make the qualified benefit taxable.under a covenant not to compete) as performing services.

Generally, a cafeteria plan does not include any planProvider of benefit. You are the provider of a fringe that offers a benefit that defers pay. However, a cafeteriabenefit if it is provided for services performed for you. You plan can include a qualified 401(k) plan as a benefit. Also,may be the provider of the benefit even if it was actually certain life insurance plans maintained by educational in-furnished by another person. You are the provider of a stitutions can be offered as a benefit even though theyfringe benefit your client or customer provides to your defer pay.employee for services the employee performs for you.

Qualified benefits. Qualified benefits include the follow-Recipient of benefit. The person who performs servicesing benefits discussed in section 2.for you is the recipient of a fringe benefit provided for those

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A highly compensated employee for this purpose is any• Accident and health benefits (but not medical sav- of the following employees.ings accounts, health savings accounts, or long-termcare insurance). 1. An officer.

• Adoption assistance. 2. A shareholder who owns more than 5% of the votingpower or value of all classes of the employer’s stock.• Dependent care assistance.

3. An employee who is highly compensated based on• Group-term life insurance coverage (including coststhe facts and circumstances.that cannot be excluded from wages).

4. A spouse or dependent of a person described in (1),(2), or (3).Benefits not allowed. A cafeteria plan cannot include

the following benefits discussed in section 2.Plans that favor key employees. If your plan favors key• Archer medical savings accounts or health savingsemployees, you must include in their wages the value ofaccounts. (See Accident and Health Benefits.)taxable benefits they could have selected. A plan favors

• Athletic facilities. key employees if more than 25% of the total of the nontax-able benefits you provide for all employees under the plan• De minimis (minimal) benefits.go to key employees. However, a plan you maintain under

• Educational assistance. a collective bargaining agreement does not favor key em-ployees.• Employee discounts.

A key employee during 2005 is generally an employee• Lodging on your business premises. who is either of the following.• Health savings accounts. 1. An officer having annual pay of more than $135,000.• Meals. 2. An employee who for 2005 was either of the follow-

ing.• Moving expense reimbursements.• No-additional-cost services. a. A 5% owner of your business.• Transportation (commuting) benefits. b. A 1% owner of your business whose annual pay

was more than $150,000.• Tuition reduction.• Working condition benefits.

More information. For more information about cafeteriaIt also cannot include scholarships or fellowships (dis- plans, see section 125 of the Internal Revenue Code and

cussed in Publication 970, Tax Benefits for Education). its regulations.

Employee. For these plans, treat the following individualsas employees. 2. Fringe Benefit Exclusion

• A current common-law employee (see section 2 in RulesPublication 15, (Circular E), for more information).• A full-time life insurance agent who is a current stat- This section discusses the exclusion rules that apply to

utory employee. fringe benefits. These rules exclude all or part of the valueof certain benefits from the recipient’s pay.• A leased employee who has provided services to

The excluded benefits are not subject to federal incomeyou on a substantially full-time basis for at least atax withholding. Also, in most cases, they are not subject toyear if the services are performed under your pri-social security, Medicare, or federal unemploymentmary direction or control.(FUTA) tax and are not reported on Form W-2.

This section discusses the exclusion rules for the follow-Exception for S corporation shareholders. Do noting fringe benefits.treat a 2% shareholder of an S corporation as an employee

of the corporation for this purpose. A 2% shareholder for • Accident and health benefits.this purpose is someone who directly or indirectly owns (at • Achievement awards.any time during the year) more than 2% of thecorporation’s stock or stock with more than 2% of the • Adoption assistance.voting power. • Archer medical savings accounts.Plans that favor highly compensated employees. If • Athletic facilities.your plan favors highly compensated employees as to • De minimis (minimal) benefits.eligibility to participate, contributions, or benefits, you mustinclude in their wages the value of taxable benefits they • Dependent care assistance.could have selected. A plan you maintain under a collec- • Educational assistance.tive bargaining agreement does not favor highly compen-sated employees. • Employee discounts.

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• Employee stock options. • No-additional-cost services.• Group-term life insurance coverage. • Transportation (commuting) benefits.• Health savings accounts. • Tuition reduction.• Lodging on your business premises. • Working condition benefits.• Meals. See Table 2–1 for an overview of the employment tax• Moving expense reimbursements. treatment of these benefits.

Table 2–1. Special Rules for Various Types of Fringe Benefits(For more information, see the full discussion in this section.)

Treatment Under Employment Taxes

Type of Fringe Benefit Income Tax Withholding Social Security and Medicare Federal Unemployment (FUTA)

Exempt1,2, except for certain Exempt, except for certain Exemptlong-term care benefits payments to S corporationAccident and health benefits employees who are 2%

shareholders.

Achievement awards Exempt1 up to $1,600 ($400 for nonqualified awards).

Adoption assistance Exempt1 Taxable Taxable

Exempt if substantially all use during the calendar year is by employees, their spouses, and theirAthletic facilities dependent children.

De minimis (minimal) benefits Exempt Exempt Exempt

Dependent care assistance Exempt3 up to certain limits, $5,000 ($2,500 for married employee filing separate return).

Educational assistance Exempt up to $5,250 of benefits each year. (See Educational Assistance on page 7.)

Employee discounts Exempt4 up to certain limits. (See Employee Discounts on page 8.)

Employee stock options See Employee Stock Options on page 8.

Exempt Exempt1,5 up to cost of $50,000 ExemptGroup-term life insurance of coverage. (Special rules applycoverage to former employees.)

Lodging on your business Exempt1 if furnished for your convenience as a condition of employment.premises

Exempt if furnished on your business premises for your convenience.Meals

Exempt if de minimis.

Moving expense reimbursements Exempt1 if expenses would be deductible if the employee had paid them.

No-additional cost services Exempt4 Exempt4 Exempt4

Exempt1 up to certain limits if for rides in a commuter highway vehicle ($105), transit passes ($105), orqualified parking ($200). (See Transportation (Commuting Benefits) on page 14.)Transportation (commuting)

benefitsExempt if de minimis.

Tuition reduction Exempt4 if for undergraduate education (or graduate education if the employee performs teaching orresearch activities).

Working condition benefits Exempt Exempt Exempt

1 Exemption does not apply to S corporation employees who are 2% shareholders. See page 3.2 Exemption does not apply to certain highly compensated employees under a self-insured plan that favors those employees.3 Exemption does not apply to certain highly compensated employees under a program that favors those employees.4 Exemption does not apply to certain highly compensated employees.5 Exemption does not apply to certain key employees under a plan that favors those employees.

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insurance from an employee’s wages subject to federalAccident and Health Benefitsincome tax withholding if the coverage is provided througha flexible spending or similar arrangement. This is a benefitThis exclusion applies to contributions you make to anprogram that reimburses specified expenses up to a maxi-accident or health plan for an employee, including themum amount that is reasonably available to the employeefollowing.and is less than five times the total cost of the insurance.• Contributions to the cost of accident or health insur- However, you can exclude these contributions from theance. employee’s wages subject to social security, Medicare,

• Contributions to a separate trust or fund that directly and federal unemployment (FUTA) taxes.or through insurance provides accident or health S corporation shareholders. Because you cannotbenefits. treat a 2% shareholder of an S corporation as an employee

• Contributions to Archer MSAs or health savings ac- for this exclusion, you must include the value of accident orcounts (discussed in Publication 969, Health Sav- health benefits you provide to the employee in theings Accounts and Other Tax-Favored Health employee’s wages subject to federal income tax withhold-Plans). ing. However, you can exclude the value of these benefits

(other than payments for specific injuries or illnesses) fromThis exclusion also applies to payments you directly or the employee’s wages subject to social security, Medicare,

indirectly make to an employee under an accident or health and FUTA taxes.plan for employees that are either of the following.

Exception for highly compensated employees. If• Payments or reimbursements of medical expenses. your plan is a self-insured medical reimbursement plan

that favors highly compensated employees, you must in-• Payments for specific injuries or illnesses (such asclude all or part of the amounts you pay to these employ-the loss of the use of an arm or leg). The paymentsees in their wages subject to federal income taxmust be figured without regard to any period of ab-withholding. However, you can exclude these amountssence from work.(other than payments for specific injuries or illnesses) fromthe employee’s wages subject to social security, Medicare,

Accident or health plan. This is an arrangement that and FUTA taxes.provides benefits for your employees, their spouses, and A self-insured plan is a plan that reimburses your em-their dependents in the event of personal injury or sick- ployees for medical expenses not covered by an accidentness. The plan may be insured or noninsured and does not or health insurance policy.need to be in writing. A highly compensated employee for this exception isEmployee. For this exclusion, treat the following individu- any of the following individuals.als as employees. • One of the five highest paid officers.

• A current common-law employee. • An employee who owns (directly or indirectly) more• A full-time life insurance agent who is a current stat- than 10% in value of the employer’s stock.

utory employee. • An employee who is among the highest paid 25% of• A retired employee. all employees (other than those who can be ex-

cluded from the plan).• A former employee you maintain coverage for basedon the employment relationship.

For more information on this exception, see section• A widow or widower of an individual who died while 105(h) of the Internal Revenue Code and its regulations.

an employee.COBRA premiums. The exclusion for accident and

• A widow or widower of a retired employee. health benefits applies to amounts you pay to maintainmedical coverage for a former employee under the Com-• For the exclusion of contributions to an accident orbined Omnibus Budget Reconciliation Act of 1986health plan, a leased employee who has provided(COBRA). The exclusion applies regardless of the lengthservices to you on a substantially full-time basis forof employment, whether you directly pay the premiums orat least a year if the services are performed underreimburse the former employee for premiums paid, andyour primary direction or control.whether the employee’s separation is permanent or tem-porary.Exception for S corporation shareholders. Do not

treat a 2% shareholder of an S corporation as an employeeof the corporation for this purpose. A 2% shareholder is Achievement Awardssomeone who directly or indirectly owns (at any time dur-

This exclusion applies to the value of any tangible personaling the year) more than 2% of the corporation’s stock orproperty you give to an employee as an award for eitherstock with more than 2% of the voting power.length of service or safety achievement. The exclusion

Exclusion from wages. You can generally exclude the does not apply to awards of cash, cash equivalents, giftvalue of accident or health benefits you provide to an certificates, or other intangible property such as vacations,employee from the employee’s wages. meals, lodging, tickets to theater or sporting events,

stocks, bonds, and other securities. The award must meetException for certain long-term care benefits. Youcannot exclude contributions to the cost of long-term care the requirements for employee achievement awards dis-

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cussed in chapter 2 of Publication 535, Business Ex- tion. A 2% shareholder is someone who directly orpenses. indirectly owns (at any time during the year) more than 2%

of the corporation’s stock or stock with more than 2% of theEmployee. For this exclusion, treat the following individu- voting power.als as employees.

• A current employee. Athletic Facilities• A former common-law employee you maintain cover-

You can exclude the value of an employee’s use of anage for in consideration of or based on an agree-on-premises gym or other athletic facility you operate fromment relating to prior service as an employee.an employee’s wages if substantially all use of the facility

• A leased employee who has provided services to during the calendar year is by your employees, theiryou on a substantially full-time basis for at least a spouses, and their dependent children. For this purpose,year if the services are performed under your pri- an employee’s dependent child is a child or stepchild whomary direction or control. is the employee’s dependent or who, if both parents are

deceased, is age 24 or younger.Exception for S corporation shareholders. Do not

On-premises facility. The athletic facility must be locatedtreat a 2% shareholder of an S corporation as an employeeon premises you own or lease. It does not have to beof the corporation for this purpose. A 2% shareholder islocated on your business premises. However, the exclu-someone who directly or indirectly owns (at any time dur-sion does not apply to an athletic facility for residential use,ing the year) more than 2% of the corporation’s stock orsuch as athletic facilities that are part of a resort.stock with more than 2% of the voting power.

Employee. For this exclusion, treat the following individu-Exclusion from wages. You can generally exclude theals as employees.value of achievement awards you give to an employee

from the employee’s wages if their cost is not more than • A current employee.the amount you can deduct as a business expense for the

• A former employee who retired or left on disability.year. The excludable annual amount is $1,600 ($400 forawards that are not “qualified plan awards”). See chapter 2 • A widow or widower of an individual who died whileof Publication 535 for more information on the limit on an employee.deductions for employee achievement awards.

• A widow or widower of a former employee who re-To determine for 2005 whether an achievement tired or left on disability.award is a “qualified plan award” under the de-

• A leased employee who has provided services toduction rules described in Publication 535, treatCAUTION!

you on a substantially full-time basis for at least aany employee who received more than $95,000 in pay foryear if the services are performed under your pri-2004 as a highly compensated employee.mary direction or control.If the cost of awards given to an employee is more than

your allowable deduction, include in the employee’s wages • A partner who performs services for a partnership.the larger of the following amounts.

• The part of the cost that is more than your allowableDe Minimis (Minimal) Benefitsdeduction (up to the value of the awards).

• The amount by which the value of the awards ex- You can exclude the value of a de minimis benefit youceeds your allowable deduction. provide to an employee from the employee’s wages. A de

minimis benefit is any property or service you provide to anExclude the remaining value of the awards from theemployee that has so little value (taking into account howemployee’s wages.frequently you provide similar benefits to your employees)that accounting for it would be unreasonable or administra-tively impracticable. Cash, no matter how little, is neverAdoption Assistanceexcludable as a de minimis benefit, except for occasional

You must exclude all payments or reimbursements you meal money or transportation fare.make under an adoption assistance program for an Examples of de minimis benefits include the following.employee’s qualified adoption expenses from the • Occasional personal use of a company copying ma-employee’s wages subject to federal income tax withhold-

chine if you sufficiently control its use so that at leasting. However, you cannot exclude these payments from85% of its use is for business purposes.wages subject to social security, Medicare, and federal

unemployment (FUTA) taxes. For more information, see • Holiday gifts, other than cash, with a low fair marketPublication 968, Tax Benefits for Adoption. value.

You must report all qualifying adoption expenses you • Group-term life insurance payable on the death of anpaid or reimbursed under your adoption assistance pro-employee’s spouse or dependent if the face amountgram for each employee for the year in box 12 of theis not more than $2,000.employee’s Form W-2. Use Code “T” to identify this

amount. • Meals. See Meals on page 11.Employee. For this exclusion, do not treat a 2% share- • Occasional parties or picnics for employees andholder of an S corporation as an employee of the corpora- their guests.

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• Occasional tickets for entertainment or sporting For this exclusion, a highly compensated employee forevents. 2005 is an employee who meets either of the following

tests.• Transportation fare. See Transportation (Commut-ing) Benefits on page 14. 1. The employee was a 5% owner at any time during

the year or the preceding year.• Occasional typing of personal letters by a companysecretary. 2. The employee received more than $95,000 in pay for

the preceding year.Employee. For this exclusion, treat any recipient of a de You can choose to ignore test (2) if the employee was notminimis benefit as an employee. also in the top 20% of employees when ranked by pay for

the preceding year.Dependent Care Assistance

Form W-2. Report the value of all dependent care assis-This exclusion applies to household and dependent care tance you provide to an employee under a dependent careservices you directly or indirectly pay for or provide to an assistance program in box 10 of the employee’s Form W-2.employee under a dependent care assistance program Include any amounts you cannot exclude from thethat covers only your employees. The services must be for employee’s wages in boxes 1, 3, and 5.a qualifying person’s care and must allow the employee towork. These requirements are basically the same as the

Educational Assistancetests the employee would have to meet to claim the depen-dent care credit if the employee paid for the services. For

This exclusion applies to educational assistance you pro-more information, see Qualifying Person Test andvide to employees under an educational assistance pro-Work-Related Expense Test in Publication 503, Child andgram. The exclusion also applies to graduate levelDependent Care Expenses.courses.

Educational assistance means amounts you pay or in-Employee. For this exclusion, treat the following individu-cur for your employees’ education expenses. These ex-als as employees.penses generally include the cost of books, equipment,

• A current employee. fees, supplies, and tuition. However, these expenses donot include the cost of a course or other education involv-• A leased employee who has provided services toing sports, games, or hobbies, unless the education:you on a substantially full-time basis for at least a

year if the services are performed under your pri- • Has a reasonable relationship to your business, ormary direction or control.

• Is required as part of a degree program.• Yourself (if you are a sole proprietor).Education expenses do not include the cost of tools or• A partner who performs services for a partnership.

supplies (other than textbooks) your employee is allowedto keep at the end of the course. Nor do they include the

Exclusion from wages. You can exclude the value of cost of lodging, meals, or transportation.benefits you provide to an employee under a dependentcare assistance program from the employee’s wages if you Educational assistance program. An educational assis-reasonably believe that the employee can exclude the tance program is a separate written plan that providesbenefits from gross income. educational assistance only to your employees. The pro-

An employee can generally exclude from gross income gram qualifies only if all of the following tests are met.up to $5,000 of benefits received under a dependent care

• The program benefits employees who qualify underassistance program each year. This limit is reduced torules set up by you that do not favor highly compen-$2,500 for married employees filing separate returns.sated employees. To determine whether your pro-However, the exclusion cannot be more than the earnedgram meets this test, do not consider employeesincome of either:excluded from your program who are covered by acollective bargaining agreement if there is evidence• The employee, orthat educational assistance was a subject of• The employee’s spouse. good-faith bargaining.

Special rules apply to determine the earned income of a • The program does not provide more than 5% of itsspouse who is either a student or not able to care for benefits during the year for shareholders or owners.himself or herself. For more information on the earned A shareholder or owner is someone who owns (onincome limit, see Pub. 503. any day of the year) more than 5% of the stock or of

the capital or profits interest of your business.Exception for highly compensated employees. Youcannot exclude dependent care assistance from the • The program does not allow employees to choose towages of a highly compensated employee unless the ben- receive cash or other benefits that must be includedefits provided under the program do not favor highly com- in gross income instead of educational assistance.pensated employees and the program meets the

• You give reasonable notice of the program to eligiblerequirements described in section 129(d) of the Internalemployees.Revenue Code.

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Your program can cover former employees if their employ- • A leased employee who has provided services toment is the reason for the coverage. you on a substantially full-time basis for at least a

year if the services are performed under your pri-For this exclusion, a highly compensated employee for mary direction or control.2005 is an employee who meets either of the followingtests. • A partner who performs services for a partnership.

1. The employee was a 5% owner at any time duringExclusion from wages. You can generally exclude thethe year or the preceding year.value of an employee discount you provide an employee

2. The employee received more than $95,000 in pay for from the employee’s wages, up to the following limits.the preceding year.

• For a discount on services, 20% of the price youYou can choose to ignore test (2) if the employee was not charge nonemployee customers for the service.also in the top 20% of employees when ranked by pay for

• For a discount on merchandise or other property,the preceding year.your gross profit percentage times the price youcharge nonemployee customers for the property.Employee. For this exclusion, treat the following individu-

als as employees.Determine your gross profit percentage based on all

• A current employee. property you offer to customers (including employee cus-tomers) and your experience during the tax year immedi-• A former employee who retired, left on disability, orately before the tax year in which the discount is available.was laid off.To figure your gross profit percentage, subtract the total

• A leased employee who has provided services to cost of the property from the total sales price of the prop-you on a substantially full-time basis for at least a erty and divide the result by the total sales price of theyear if the services are performed under your pri- property.mary direction or control.

Exception for highly compensated employees. You• Yourself (if you are a sole proprietor). cannot exclude from the wages of a highly compensated

employee any part of the value of a discount that is not• A partner who performs services for a partnership.available on the same terms to one of the following groups.

• All of your employees.Exclusion from wages. You can exclude up to $5,250 ofeducational assistance you provide to an employee under • A group of employees defined under a reasonablean educational assistance program from the employee’s classification you set up that does not favor highlywages each year. compensated employees.

Assistance over $5,250. If you do not have an educa-For this exclusion, a highly compensated employee fortional assistance plan, or you provide an employee with

2005 is an employee who meets either of the followingassistance exceeding $5,250, you can exclude the valuetests.of these benefits from wages if they are working condition

benefits. Property or a service provided is a working condi-1. The employee was a 5% owner at any time duringtion benefit to the extent that if the employee paid for it, the

the year or the preceding year.amount paid would have been deductible as a business ordepreciation expense. See Working Condition Benefits, on 2. The employee received more than $95,000 in pay forpage 15. the preceding year.

You can choose to ignore test (2) if the employee was notEmployee Discounts also in the top 20% of employees when ranked by pay forthe preceding year.This exclusion applies to a price reduction you give an

employee on property or services you offer to customers inEmployee Stock Optionsthe ordinary course of the line of business in which the

employee performs substantial services. However, it doesThere are three kinds of stock options—incentive stocknot apply to discounts on real property or discounts onoptions, employee stock purchase plan options, and non-personal property of a kind commonly held for investmentstatutory (nonqualified) stock options.(such as stocks or bonds).

Wages for social security, Medicare, and federal unem-Employee. For this exclusion, treat the following individu- ployment taxes (FUTA) do not include remuneration result-als as employees. ing from the exercise after October 22, 2004, of an

incentive stock option or an employee stock purchase plan• A current employee. option, or from any disposition of stock acquired by exer-cising such an option. The IRS will not apply these taxes to• A former employee who retired or left on disability.an exercise before October 23, 2004, of an incentive stock• A widow or widower of an individual who died while option or an employee stock purchase plan option, or to a

an employee. disposition of stock acquired by such exercise.• A widow or widower of an employee who retired or Additionally, federal income tax withholding is not re-

left on disability. quired on the income resulting from a disqualifying disposi-

Page 8



tion of stock acquired by the exercise after October 22, Group-term life insurance does not include the following2004, of an incentive stock option or an employee stock insurance.purchase plan option, or on income equal to the discount • Insurance that does not provide general death bene-portion of stock acquired by the exercise after October 22,

fits, such as travel insurance or a policy providing2004, of an employee stock purchase plan option resultingonly accidental death benefits.from any disposition of the stock. The IRS will not apply

federal income tax withholding upon the disposition of • Life insurance on the life of your employee’s spousestock acquired by the exercise before October 23, 2004, of or dependent. However, you may be able to excludean incentive stock option or an employee stock purchase the cost of this insurance from the employee’splan option. However, the employer must report as income wages as a de minimis benefit. See De Minimisin box 1 of Form W-2, 1) the discount portion of stock (Minimal) Benefits on page 6.acquired by the exercise of an employee stock purchase • Insurance provided under a policy that provides aplan option upon disposition of the stock, and 2) the spread

permanent benefit (an economic value that extends(between the exercise price and the fair market value ofbeyond 1 policy year, such as paid-up or cash sur-the stock at the time of exercise) upon a disqualifyingrender value), unless certain requirements are met.disposition of stock acquired by the exercise of an incen-See Regulations section 1.79-1 for details.tive stock option or an employee stock purchase plan

option.Employee. For this exclusion, treat the following individu-The spread on nonstatutory options normally is includedals as employees.in wages for income tax purposes when the options are

exercised. (See Regulations section 1.83-7.) The spread1. A current common-law employee.on nonstatutory options is subject to social security, Medi-

care, FUTA, and federal income tax withholding at the time 2. A full-time life insurance agent who is a current statu-of exercise. tory employee.

An employee who transfers his or her interest in non- 3. An individual who was formerly your employee understatutory stock options to the employee’s former spouse (1) or (2), above.incident to a divorce is not required to include an amount in

4. A leased employee who has provided services to yougross income upon the transfer. The former spouse, ratheron a substantially full-time basis for at least a year ifthan the employee, is required to include an amount inthe services are performed under your primary direc-gross income when the former spouse exercises the stocktion and control.options. See Revenue Ruling 2002-22 and Revenue Rul-

ing 2004-60 for details. You can find Rev. Rul. 2002-22 on Exception for S corporation shareholders. Do notpage 849 of Internal Revenue Bulletin 2002-19 attreat a 2% shareholder of an S corporation as an employeewww.irs.gov/pub/irs-irbs/irb02-19.pdf. You can find Rev.of the corporation for this purpose. A 2% shareholder isRul. 2004-60 on page 1051 of Internal Revenue Bulletinsomeone who directly or indirectly owns (at any time dur-2004-24 at www.irs.gov/pub/irs-irbs/irb04-24.pdf.ing the year) more than 2% of the corporation’s stock or

For more information about employee stock options, stock with more than 2% of the voting power.see sections 421, 422, and 423 of the Internal RevenueCode and the related regulations. The 10-employee rule. Generally, life insurance is not

group-term life insurance unless you provide it to at leastGroup-Term Life Insurance Coverage 10 full-time employees at some time during the year.

For this rule, count employees who choose not to re-This exclusion applies to life insurance coverage that ceive the insurance unless, to receive it, they must contrib-meets all the following conditions. ute to the cost of benefits other than the group-term life

insurance. For example, count an employee who could• It provides a general death benefit that is not in- receive insurance by paying part of the cost, even if thatcluded in income. employee chooses not to receive it. However, do not countan employee who must pay part or all of the cost of• You provide it to a group of employees. See Thepermanent benefits to get insurance, unless that employee10-employee rule below.chooses to receive it.• It provides an amount of insurance to each em-

Exceptions. Even if you do not meet the 10-employeeployee based on a formula that prevents individualrule, two exceptions allow you to treat insurance asselection. This formula must use factors such as thegroup-term life insurance.employee’s age, years of service, pay, or position.

Under the first exception, you do not have to meet the• You provide it under a policy you directly or indirectly10-employee rule if all the following conditions are met.carry. Even if you do not pay any of the policy’s cost,

you are considered to carry it if you arrange for 1. If evidence that the employee is insurable is re-payment of its cost by your employees and charge at quired, it is limited to a medical questionnaire (com-least one employee less than, and at least one other pleted by the employee) that does not require aemployee more than, the cost of his or her insur- physical.ance. Determine the cost of the insurance, for thispurpose, as explained under Coverage over the limit 2. You provide the insurance to all your full-time em-on page 10. ployees or, if the insurer requires the evidence men-

Page 9



50 through 54 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .23tioned in (1), to all full-time employees who provide55 through 59 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .43evidence the insurer accepts.60 through 64 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .66

3. You figure the coverage based on either a uniform 65 through 69 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.27percentage of pay or the insurer’s coverage brackets 70 and older . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.06that meet certain requirements. See Regulations

You figure the total cost to include in the employee’ssection 1.79-1 for details.wages by multiplying the monthly cost by the number of full

Under the second exception, you do not have to meet months’ coverage at that cost.the 10-employee rule if all the following conditions are met.

Example. Tom’s employer provides him with• You provide the insurance under a common plangroup-term life insurance coverage of $200,000. Tom is 45covering your employees and the employees of atyears old, is not a key employee, and pays $100 per yearleast one other employer who is not related to you.toward the cost of the insurance. Tom’s employer must

• The insurance is restricted to, but mandatory for, all include $170 in his wages. The total cost of the insurance,your employees who belong to, or are represented $360 ($.15 × 200 × 12), is reduced by the cost of $50,000 ofby, an organization (such as a union) that carries on coverage, $90 ($.15 × 50 × 12), and by the $100 Tom payssubstantial activities besides obtaining insurance. for the insurance. The employer includes $170 in boxes 1,

3, and 5 of Tom’s Form W-2. The employer also enters• Evidence of whether an employee is insurable does$170 in box 12 with code C.not affect an employee’s eligibility for insurance or

the amount of insurance that employee gets. Coverage for dependents. Group-term life insurancecoverage paid by the employer for the spouse or depen-

To apply either exception, do not consider employees dents of an employee may be excludable from income as awho were denied insurance for any of the following rea- de minimis fringe benefit (see page 6). The part of thissons. coverage that the employee paid on an after-tax basis is

also excludable from income. For this purpose, the cost is• They were 65 or older.figured using the monthly cost table above.

• They customarily work 20 hours or less a week or 5Former employees. For group-term life insurance overmonths or less in a calendar year.

$50,000 provided to former employees (including retirees),• They have not been employed for the waiting period the former employees must pay the employee’s share of

given in the policy. (This waiting period cannot be social security and Medicare taxes with their income taxmore than 6 months.) returns. You are not required to collect those taxes. Use

the table above to determine the amount of social securityand Medicare taxes owed by the former employee forExclusion from wages. You can generally exclude thecoverage provided after separation from service. Reportcost of up to $50,000 of group-term life insurance from thethose uncollected amounts separately in box 12 on Formwages of an insured employee. You can exclude the sameW-2 using codes M and N. See the Instructions for Formsamount from the employee’s wages when figuring socialW-2 and W-3.security and Medicare taxes. In addition, you do not have

to withhold federal income tax or pay FUTA tax on any Exception for key employees. Generally, if yourgroup-term life insurance you provide to an employee. group-term life insurance plan favors key employees as to

participation or benefits, you must include the entire cost ofCoverage over the limit. You must include in yourthe insurance in your key employees’ wages. (This excep-employee’s wages subject to social security and Medicaretion generally does not apply to church plans.) Whentaxes the cost of group-term life insurance that is morefiguring social security and Medicare taxes, you must alsothan the cost of $50,000 of coverage, reduced by theinclude the entire cost in the employees’ wages. Includeamount the employee paid toward the insurance. Report itthe cost in boxes 1, 3, and 5 of Form W-2. However, you doas wages in boxes 1, 3, and 5 of the employee’s Form W-2.not have to withhold federal income tax or pay FUTA tax onAlso, show it in box 12 with code C.the cost of any group-term life insurance you provide to anFigure the monthly cost of the insurance to include in theemployee.employee’s wages by multiplying the number of thousands

For this purpose, the cost of the insurance is the greaterof dollars of insurance coverage over $50,000 (figured toof the following amounts.the nearest $100) by the cost shown in the following table.

Use the employee’s age on the last day of the tax year. • The premiums you pay for the employee’s insur-You must prorate the cost from the table if less than a full ance.month of coverage is involved.

• The cost you figure using the table shown laterCost Per $1,000 of Protection under Coverage over the limit.

For 1 Month

For this exclusion, a key employee during 2005 is anAge Cost employee or former employee who is one of the followingUnder 25 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ .05 individuals. See section 416(i) for more information.25 through 29 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .0630 through 34 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .08 1. An officer having annual pay of more than $135,000.35 through 39 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .09

2. An individual who for 2005 was either of the follow-40 through 44 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1045 through 49 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15 ing.

Page 10



a. A 5% owner of your business. Different tests may apply to lodging furnished by educa-tional institutions. See section 119(d) of the Internal Reve-b. A 1% owner of your business whose annual pay nue Code for details.

was more than $150,000.The exclusion does not apply if you allow your employee

to choose to receive additional pay instead of lodging.A former employee who was a key employee uponretirement or separation from service is also a key em-

On your business premises. For this exclusion, yourployee.business premises is generally your employee’s place of

Your plan does not favor key employees as to partici- work. (For special rules that apply to lodging furnished in apation if at least one of the following is true. camp located in a foreign country, see section 119(c) of the

Internal Revenue Code and its regulations.)• It benefits at least 70% of your employees.• At least 85% of the participating employees are not For your convenience. Whether or not you furnish lodg-

ing for your convenience as an employer depends on allkey employees.the facts and circumstances. You furnish the lodging to• It benefits employees who qualify under a set of your employee for your convenience if you do this for a

rules you set up that do not favor key employees. substantial business reason other than to provide the em-ployee with additional pay. This is true even if a law or an

Your plan meets this participation test if it is part of a employment contract provides that the lodging is furnishedcafeteria plan (discussed in section 1) and it meets the as pay. However, a written statement that the lodging isparticipation test for those plans. furnished for your convenience is not sufficient.

When applying this test, do not consider employeesCondition of employment. Lodging meets this test if youwho:require your employees to accept the lodging because• Have not completed 3 years of service, they need to live on your business premises to be able toproperly perform their duties. Examples include employ-• Are part-time or seasonal,ees who must be available at all times and employees who• Are nonresident aliens who receive no U.S. source could not perform their required duties without being fur-

earned income from you, or nished the lodging.It does not matter whether you must furnish the lodging• Are not included in the plan but are in a unit of

as pay under the terms of an employment contract or a lawemployees covered by a collective bargaining agree-fixing the terms of employment.ment, if the benefits provided under the plan were

the subject of good-faith bargaining between youExample. A hospital gives Joan, an employee of theand employee representatives.

hospital, the choice of living at the hospital free of charge orliving elsewhere and receiving a cash allowance in additionYour plan does not favor key employees as to benefits ifto her regular salary. If Joan chooses to live at the hospital,all benefits available to participating key employees arethe hospital cannot exclude the value of the lodging fromalso available to all other participating employees. Yourher wages because she is not required to live at theplan does not favor key employees just because the hospital to properly perform the duties of her employment.

amount of insurance you provide to your employees isuniformly related to their pay. S corporation shareholders. For this exclusion, do not

treat a 2% shareholder of an S corporation as an employeeS corporation shareholders. Because you cannotof the corporation. A 2% shareholder is someone whotreat a 2% shareholder of an S corporation as an employeedirectly or indirectly owns (at any time during the year)for this exclusion, you must include the cost of allmore than 2% of the corporation’s stock or stock with moregroup-term life insurance coverage you provide the 2%than 2% of the voting power.shareholder in his or her wages. When figuring social

security and Medicare taxes, you must also include theMealscost of this coverage in the 2% shareholder’s wages.

Include the cost in boxes 1, 3, and 5 of Form W-2. How-This section discusses the exclusion rules that apply to deever, you do not have to withhold federal income tax or payminimis meals and meals on your business premises.federal unemployment tax on the cost of any group-term

life insurance coverage you provide to the 2% shareholder.De Minimis Meals

Lodging on Your Business PremisesThis exclusion applies to any meal or meal money youprovide to an employee if it has so little value (taking intoYou can exclude the value of lodging you furnish to anaccount how frequently you provide meals to your employ-employee from the employee’s wages if it meets the follow-ees) that accounting for it would be unreasonable or ad-ing tests.ministratively impracticable. The exclusion applies, for

• It is furnished on your business premises. example, to the following items.• It is furnished for your convenience. • Coffee, doughnuts, or soft drinks.• The employee must accept it as a condition of em- • Occasional meals or meal money provided to enable

ployment. an employee to work overtime. (However, the exclu-

Page 11



sion does not apply to meal money figured on the Meals on Your Business Premisesbasis of hours worked.)

You can exclude the value of meals you furnish to an• Occasional parties or picnics for employees and employee from the employee’s wages if they meet thetheir guests. following tests.

• They are furnished on your business premises.This exclusion also applies to meals you provide at anemployer-operated eating facility for employees if the an- • They are furnished for your convenience.nual revenue from the facility equals or exceeds the directcosts of the facility. For this purpose, your revenue from This exclusion does not apply if you allow your employeeproviding a meal is considered equal to the facility’s direct to choose to receive additional pay instead of meals.operating costs to provide that meal if its value can beexcluded from an employee’s wages as explained under On your business premises. Generally, for this exclu-Meals on Your Business Premises later. sion, the employee’s place of work is your business prem-

ises.If food or beverages you furnish to employeesqualify as a de minimis benefit, you can deduct For your convenience. Whether you furnish meals fortheir full cost. The 50% limit on deductions for the

TIPyour convenience as an employer depends on all the facts

cost of meals does not apply. The deduction limit on meals and circumstances. You furnish the meals to your em-is discussed in chapter 2 of Publication 535. ployee for your convenience if you do this for a substantial

business reason other than to provide the employee withEmployee. For this exclusion, treat any recipient of a de additional pay. This is true even if a law or an employmentminimis meal as an employee. contract provides that the meals are furnished as pay.

However, a written statement that the meals are furnishedEmployer-operated eating facility for employees. An for your convenience is not sufficient.employer-operated eating facility for employees is an eat- Meals excluded for all employees if excluded foring facility that meets all the following conditions. more than half. If more than half of your employees who

are furnished meals on your business premises are fur-• You own or lease the facility.nished the meals for your convenience, you can treat all• You operate the facility. (You are considered to op- meals you furnish to employees on your business prem-

erate the eating facility if you have a contract with ises as furnished for your convenience.another to operate it.)

Food service employees. Meals you furnish to a res-• The facility is on or near your business premises. taurant or other food service employee during, or immedi-ately before or after, the employee’s working hours are• You provide meals (food, drinks, and related serv-furnished for your convenience. For example, if a waitressices) at the facility during, or immediately before orworks through the breakfast and lunch periods, you canafter, the employee’s workday.exclude from her wages the value of the breakfast andlunch you furnish in your restaurant for each day she

Exclusion from wages. You can generally exclude the works.value of de minimis meals you provide to an employeefrom the employee’s wages. Example. You operate a restaurant business. You fur-

nish your employee, Carol, who is a waitress working 7Exception for highly compensated employees. Youa.m. to 4 p.m., two meals during each workday. Youcannot exclude from the wages of a highly compensatedencourage but do not require Carol to have her breakfastemployee the value of a meal provided at an employer-on the business premises before starting work. She mustoperated eating facility that is not available on the samehave her lunch on the premises. Since Carol is a foodterms to one of the following groups.service employee and works during the normal breakfast

• All of your employees. and lunch periods, you can exclude from her wages thevalue of her breakfast and lunch.• A group of employees defined under a reasonable

If you also allow Carol to have meals on your businessclassification you set up that does not favor highly premises without charge on her days off, you cannot ex-compensated employees. clude the value of those meals from her wages.

For this exclusion, a highly compensated employee for Employees available for emergency calls. Meals youfurnish during working hours so an employee will be avail-2005 is an employee who meets either of the followingable for emergency calls during the meal period are fur-tests.nished for your convenience. You must be able to show

1. The employee was a 5% owner at any time during these emergency calls have occurred or can reasonablythe year or the preceding year. be expected to occur.

2. The employee received more than $95,000 in pay forExample. A hospital maintains a cafeteria on its prem-the preceding year.

ises where all of its 230 employees may get meals at noYou can choose to ignore test (2) if the employee was not charge during their working hours. The hospital furnishesalso in the top 20% of employees when ranked by pay for meals to have 120 employees available for emergencies.the preceding year. Each of these employees is, at times, called upon to

Page 12



perform services during the meal period. Although the ing the year) more than 2% of the corporation’s stock orstock with more than 2% of the voting power.hospital does not require these employees to remain on

the premises, they rarely leave the hospital during theirmeal period. Since the hospital furnishes meals on its Moving Expense Reimbursementspremises to its employees so that more than half of themare available for emergency calls during meal periods, the This exclusion applies to any amount you directly or indi-hospital can exclude the value of these meals from the rectly give an employee, (including services furnished inwages of all of its employees. kind) as payment for, or reimbursement of, moving ex-

penses. You must make the reimbursements under rulesShort meal periods. Meals you furnish during workingsimilar to those described in chapter 13 of Publication 535hours are furnished for your convenience if the nature offor reimbursements of expenses for travel, meals, andyour business restricts an employee to a short meal periodentertainment under accountable plans.(such as 30 or 45 minutes) and the employee cannot be

The exclusion applies only to reimbursements of mov-expected to eat elsewhere in such a short time. For exam-ing expenses that the employee could deduct if he or sheple, meals can qualify for this treatment if your peakhad paid or incurred them without reimbursement. How-work-load occurs during the normal lunch hour. However,ever, it does not apply if the employee actually deductedthey do not qualify if the reason for the short meal period isthe expenses in a previous year.to allow the employee to leave earlier in the day.

Deductible moving expenses include only the reasona-ble expenses of:Example. Frank is a bank teller who works from 9 a.m.

to 5 p.m. The bank furnishes his lunch without charge in a • Moving household goods and personal effects fromcafeteria the bank maintains on its premises. The bank the former home to the new home, andfurnishes these meals to Frank to limit his lunch period to • Traveling (including lodging) from the former home30 minutes, since the bank’s peak workload occurs during to the new home.the normal lunch period. If Frank got his lunch elsewhere, itwould take him much longer than 30 minutes and the bank

Deductible moving expenses do not include anystrictly enforces the time limit. The bank can exclude theexpenses for meals and must meet both the dis-value of these meals from Frank’s wages.tance test and the time test. The distance test isCAUTION

!Proper meals not otherwise available. Meals you fur- met if the new job location is at least 50 miles farther from

nish during working hours are furnished for your conve- the employee’s old home than the old job location was.nience if the employee could not otherwise eat proper The time test is met if the employee works at least 39meals within a reasonable period of time. For example, weeks during the first 12 months after arriving in the gen-meals can qualify for this treatment if there are insufficient eral area of the new job location.eating facilities near the place of employment.

For more information on deductible moving expenses,Meals after work hours. Meals you furnish to an em- see Publication 521, Moving Expenses.

ployee immediately after working hours are furnished forEmployee. For this exclusion, treat the following individu-your convenience if you would have furnished them duringals as employees.working hours for a substantial nonpay business reason

but, because of the work duties, they were not eaten during • A current employee.working hours. • A leased employee who has provided services to

Meals you furnish to promote goodwill, boost mo- you on a substantially full-time basis for at least arale, or attract prospective employees. Meals you fur- year if the services are performed under your pri-nish to promote goodwill, boost morale, or attract mary direction or control.prospective employees are not considered furnished foryour convenience. However, you may be able to exclude Exception for S corporation shareholders. Do nottheir value as discussed under De Minimis Meals on treat a 2% shareholder of an S corporation as an employeepage 11. of the corporation for this purpose. A 2% shareholder is

someone who directly or indirectly owns (at any time dur-Meals furnished on nonworkdays or with lodging.ing the year) more than 2% of the corporation’s stock orYou generally cannot exclude from an employee’s wagesstock with more than 2% of the voting power.the value of meals you furnish on a day when the employee

is not working. However, you can exclude these meals if Exclusion from wages. You can generally exclude quali-they are furnished with lodging that is excluded from the fying moving expense reimbursements you provide to anemployee’s wages as discussed under Lodging on Your employee from the employee’s wages. If you paid theBusiness Premises on page 11. reimbursements directly to the employee, report the

amount in box 12 of Form W-2 with the code P. Do notMeals with a charge. The fact that you charge for thereport payments to a third party for the employee’s movingmeals and that your employees may accept or decline theexpenses or the value of moving services you provided inmeals is not taken into account in determining whether orkind.not meals are furnished for your convenience.

S corporation shareholder-employee. For this exclu- No-Additional-Cost Servicession, do not treat a 2% shareholder of an S corporation asan employee of the corporation. A 2% shareholder is This exclusion applies to a service you provide to ansomeone who directly or indirectly owns (at any time dur- employee if it does not cause you to incur any substantial

Page 13



additional costs. The service must be offered to customers Exclusion from wages. You can generally exclude thein the ordinary course of the line of business in which the value of a no-additional-cost service you provide to anemployee performs substantial services. employee from the employee’s wages.

Generally, no-additional-cost services are excess ca- Exception for highly compensated employees. Youpacity services, such as airline, bus, or train tickets; hotel cannot exclude from the wages of a highly compensatedrooms; or telephone services provided free or at a reduced employee the value of a no-additional-cost service that isprice to employees working in those lines of business. not available on the same terms to one of the followinggroups.Substantial additional costs. To determine whether you

incur substantial additional costs to provide a service to an • All of your employees.employee, count any lost revenue as a cost. Do not reduce

• A group of employees defined under a reasonablethe costs you incur by any amount the employee pays forclassification you set up that does not favor highlythe service. You are considered to incur substantial addi-compensated employees.tional costs if you or your employees spend a substantial

amount of time in providing the service, even if the timeFor this exclusion, a highly compensated employee forspent would otherwise be “idle” or if the services are

2005 is an employee who meets either of the followingprovided outside normal business hours.tests.

Reciprocal agreements. A no-additional-cost service1. The employee was a 5% owner at any time duringprovided to your employee by an unrelated employer may

the year or the preceding year.qualify as a no-additional-cost service if all the followingtests are met: 2. The employee received more than $95,000 in pay for

the preceding year.• The service is the same type of service generallyprovided to customers in both the line of business in You can choose to ignore test (2) if the employee was notwhich the employee works and the line of business also in the top 20% of employees when ranked by pay forin which the service is provided. the preceding year.

• You and the employer providing the service have awritten reciprocal agreement under which a group of Retirement Planning Servicesemployees of each employer, all of whom performsubstantial services in the same line of business, You may exclude from an employee’s wages the value ofmay receive no-additional-cost services from the any retirement planning advice or information you provideother employer. to your employee or his or her spouse if you maintain a

qualified retirement plan. In addition to employer plan ad-• Neither you nor the other employer incurs any sub-vice and information, the services provided may includestantial additional cost either in providing the servicegeneral advice and information on retirement. However,or because of the written agreement.the exclusion does not apply to services for tax prepara-tion, accounting, legal, or brokerage services.

Employee. For this exclusion, treat the following individu-als as employees. Transportation (Commuting) Benefits

1. A current employee. This section discusses exclusion rules that apply to bene-2. A former employee who retired or left on disability. fits you provide to your employees for their personal trans-

portation, such as commuting to and from work. These3. A widow or widower of an individual who died while rules apply to the following transportation benefits.an employee.• De minimis transportation benefits.4. A widow or widower of a former employee who re-

tired or left on disability. • Qualified transportation benefits.5. A leased employee who has provided services to you Special rules that apply to demonstrator cars and qualified

on a substantially full-time basis for at least a year if nonpersonal-use vehicles are discussed under Workingthe services are performed under your primary direc- Condition Benefits on page 15.tion or control.

De Minimis Transportation Benefits6. A partner who performs services for a partnership.Treat services you provide to the spouse or dependent You can exclude the value of any de minimis transportation

child of an employee as provided to the employee. For this benefit you provide to an employee from the employee’sfringe benefit, “dependent child” means any son, stepson, wages. A de minimis transportation benefit is any transpor-daughter, or stepdaughter who is a dependent of the em- tation benefit you provide to an employee if it has so littleployee, or both of whose parents have died and who has value (taking into account how frequently you providenot reached age 25. Treat a child of divorced parents as a transportation to your employees) that accounting for itdependent of both parents. would be unreasonable or administratively impracticable.

Treat any use of air transportation by the parent of an For example, it applies to occasional transportation fareemployee as use by the employee. This rule does not you give an employee because the employee is workingapply to use by the parent of a person considered an overtime if the benefit is reasonable and is not based onemployee because of item (3) above. hours worked.

Page 14



Employee. For this exclusion, treat any recipient of a de year if the services are performed under your pri-minimis transportation benefit as an employee. mary direction or control.

Exception for S corporation shareholders. Do notQualified Transportation Benefits treat a 2% shareholder of an S corporation as an employee

of the corporation for this purpose. A 2% shareholder isThis exclusion applies to the following benefits. someone who directly or indirectly owns (at any time dur-• A ride in a commuter highway vehicle between the ing the year) more than 2% of the corporation’s stock or

employee’s home and work place. stock with more than 2% of the voting power.

• A transit pass. Relation to other fringe benefits. You cannot exclude aqualified transportation benefit you provide to an employee• Qualified parking.under the de minimis or working condition benefit rules.

The exclusion applies whether you provide only one or a However, if you provide a local transportation benefit othercombination of these benefits to your employees. than by transit pass or commuter highway vehicle, or to a

person other than an employee, you may be able to ex-Qualified transportation benefits can be provided directlyclude all or part of the benefit under other fringe benefitby you or through a bona fide reimbursement arrange-rules (de minimis, working condition, etc.).ment. However, cash reimbursements for transit passes

qualify only if a voucher or a similar item that the employeeExclusion from wages. You can generally exclude thecan exchange only for a transit pass is not readily availablevalue of transportation benefits that you provide to anfor direct distribution by you to your employee. A voucher isemployee during 2005 from the employee’s wages up toreadily available for direct distribution only if an employeethe following limits.can obtain it from a voucher provider that does not impose

fare media charges or other restrictions that effectively • $105 per month for combined commuter highwayprevent the employer from obtaining vouchers. See Regu- vehicle transportation and transit passes.lations section 1.132-9 for more information.

• $200 per month for qualified parking.You can exclude qualified transportation fringe benefitsfrom an employee’s wages even if you provide them in

Benefits more than the limit. If the value of a benefitplace of pay. For information about providing qualifiedfor any month is more than its limit, include in thetransportation fringe benefits under a compensation reduc-employee’s wages the amount over the limit minus anyt i o n a g r e e m e n t , s e e R e g u l a t i o n s s e c t i o namount the employee paid for the benefit. You cannot1.132-9(b)(Q-11).exclude the excess from the employee’s wages as a deminimis transportation benefit.Commuter highway vehicle. A commuter highway vehi-

cle is any highway vehicle that seats at least 6 adults (notMore information. For more information on qualifiedincluding the driver). In addition, you must reasonablytransportation benefits, including van pools, and how toexpect that at least 80% of the vehicle mileage will be fordetermine the value of parking, see Regulations sectiontransporting employees between their homes and work1.132-9.place with employees occupying at least one-half the

vehicle’s seats (not including the driver’s).Tuition Reduction

Transit pass. A transit pass is any pass, token, farecard,voucher, or similar item entitling a person to ride, free of An educational organization can exclude the value of acharge or at a reduced rate, one of the following. qualified tuition reduction it provides to an employee from

the employee’s wages.• On mass transit.A tuition reduction for undergraduate education gener-

• In a vehicle that seats at least 6 adults (not including ally qualifies for this exclusion if it is for the education ofthe driver) if a person in the business of transporting one of the following individuals.persons for pay or hire operates it.

1. A current employee.Mass transit may be publicly or privately operated and

2. A former employee who retired or left on disability.includes bus, rail, or ferry.

3. A widow or widower of an individual who died whileQualified parking. Qualified parking is parking you pro- an employee.vide to your employees on or near your business premises.

4. A widow or widower of a former employee who re-It includes parking on or near the location from which yourtired or left on disability.employees commute to work using mass transit, com-

muter highway vehicles, or carpools. It does not include 5. A dependent child or spouse of any individual listedparking at or near your employee’s home. in (1) through (4) above.

A tuition reduction for graduate education qualifies forEmployee. For this exclusion, treat the following individu-this exclusion only if it is for the education of a graduateals as employees.student who performs teaching or research activities for• A current employee. the educational organization.

• A leased employee who has provided services to For more information on this exclusion, see Publicationyou on a substantially full-time basis for at least a 970, Tax Benefits for Education.

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Demonstrator cars. All of the use of a demonstrator carWorking Condition Benefitsby your full-time auto salesperson generally qualifies as aworking condition benefit if the use is primarily to facilitateThis exclusion applies to property and services you pro-the services the salesperson provided for you and therevide to an employee so that the employee can perform hisare substantial restrictions on personal use. For moreor her job. It applies to the extent the employee couldinformation and the definition of “full-time auto salesper-deduct the cost of the property or services as a businessson,” see Regulations section 1.132-5(o).expense or depreciation expense if he or she had paid for

it. The employee must meet any substantiation require-Qualified nonpersonal-use vehicles. All of anments that apply to the deduction. Examples of workingemployee’s use of a qualified nonpersonal-use vehicle is acondition benefits include an employee’s use of a companyworking condition benefit. A qualified nonpersonal-use ve-car for business and job-related education provided to anhicle is any vehicle the employee is not likely to use moreemployee.than minimally for personal purposes because of its de-

This exclusion also applies to a cash payment you sign. Qualified nonpersonal-use vehicles generally includeprovide for an employee’s expenses for a specific or prear- all of the following vehicles.ranged business activity for which a deduction is allowableto the employee. You must require the employee to verify • Clearly marked police and fire vehicles.that the payment is actually used for those expenses and • Unmarked vehicles used by law enforcement officersto return any unused part of the payment. if the use is officially authorized.

For information on deductible employee business ex-• An ambulance or hearse used for its specific pur-penses, see Unreimbursed Employee Expenses in Publi-

pose.cation 529, Miscellaneous Deductions.The exclusion does not apply to the following items. • Any vehicle designed to carry cargo with a loaded

gross vehicle weight over 14,000 pounds.• A service or property provided under a flexiblespending account in which you agree to provide the • Delivery trucks with seating for the driver only, or the

driver plus a folding jump seat.employee, over a time period, a certain level of un-specified noncash benefits with a predetermined • A passenger bus with a capacity of at least 20 pas-cash value. sengers used for its specific purpose.

• A physical examination program you provide, even if • School buses.mandatory.

• Tractors and other special-purpose farm vehicles.• Any item to the extent the employee could deduct itscost as an expense for a trade or business other Pickup trucks. A pickup truck with a loaded gross vehi-than your trade or business. cle weight of 14,000 pounds or less is a qualified

nonpersonal-use vehicle if it has been specially modifiedso it is not likely to be used more than minimally forEmployee. For this exclusion, treat the following individu-personal purposes. For example, a pickup truck qualifies ifals as employees.it is clearly marked with permanently affixed decals, spe-

• A current employee. cial painting, or other advertising associated with yourtrade, business, or function and meets either of the follow-• A partner who performs services for a partnership.ing requirements.

• A director of your company.1. It is equipped with at least one of the following items.• An independent contractor who performs services

for you. a. A hydraulic lift gate.

b. Permanent tanks or drums.Vehicle allocation rules. If you provide a car for an

c. Permanent side boards or panels that materiallyemployee’s use, the amount you can exclude as a workingraise the level of the sides of the truck bed.condition benefit is the amount that would be allowable as

a deductible business expense if the employee paid for its d. Other heavy equipment (such as an electric gen-use. That is, if the employee uses the car for both business erator, welder, boom, or crane used to tow auto-and personal use, the value of the working condition bene- mobiles and other vehicles).fit is the part determined to be for business use of thevehicle. See Business use of your car under Personal 2. It is used primarily to transport a particular type ofExpenses in chapter 1 of Publication 535. Also, see the load (other than over the public highways) in a con-special rules for certain demonstrator cars and qualified struction, manufacturing, processing, farming, min-nonpersonal-use vehicles discussed below. ing, drilling, timbering, or other similar operation for

However, instead of excluding the value of the working which it was specially designed or significantly modi-condition benefit, you can include the entire annual lease fied.value of the car in the employee’s wages. The employeecan then claim any deductible business expense for the Vans. A van with a loaded gross vehicle weight ofcar as an itemized deduction on his or her personal income 14,000 pounds or less is a qualified nonpersonal-use vehi-tax return. This option is available only if you use the lease cle if it has been specially modified so it is not likely to bevalue rule (discussed in section 3) to value the benefit. used more than minimally for personal purposes. For ex-

Page 16



ample, a van qualifies if it is clearly marked with perma- in a product testing program from the compensation youpay to a director.nently affixed decals, special painting, or other advertising

associated with your trade, business, or function and has aseat for the driver only (or the driver and one other person)and either of the following items. 3. Fringe Benefit Valuation

• Permanent shelving that fills most of the cargo area. Rules• An open cargo area and the van always carries

This section discusses the rules you must use to determinemerchandise, material, or equipment used in yourthe value of a fringe benefit you provide to an employee.trade, business, or function.You must determine the value of any benefit you cannotexclude under the rules in section 2 or for which the

Education. Certain job-related education you provide to amount you can exclude is limited. See Including taxablean employee may qualify for exclusion as a working condi- benefits in pay on page 2.tion benefit. To qualify, the education must meet the same In most cases, you must use the general valuation rulerequirements that would apply for determining whether the to value a fringe benefit. However, you may be able to useemployee could deduct the expenses had the employee a special valuation rule to determine the value of certainpaid the expenses. The education must meet at least one benefits.of the following tests. This section does not discuss the special valuation rule

used to value meals provided at an employer-operated• The education is required by the employer or by laweating facility for employees. For that rule, see Regulationsfor the employee to keep his or her present salary,section 1.61-21(j). This section also does not discuss thestatus, or job. The required education must serve aspecial valuation rules used to value the use of aircraft. Forbona fide business purpose of the employer.those rules, see Regulations sections 1.61-21(g) and (h).

• The education maintains or improves skills neededin the job. General Valuation Rule

However, even if the education meets one or both of the You must use the general valuation rule to determine theabove tests, it is not qualifying education if it: value of most fringe benefits. Under this rule, the value of a

fringe benefit is its fair market value.• Is needed to meet the minimum educational require-ments of the employee’s present trade or business, Fair market value. The fair market value (FMV) of a fringeor benefit is the amount an employee would have to pay a

third party in an arm’s-length transaction to buy or lease• Is part of a program of study that will qualify thethe benefit. Determine this amount on the basis of all theemployee for a new trade or business.facts and circumstances.

Neither the amount the employee considers to be theOutplacement services. An employee’s use of outplace- value of the fringe benefit nor the cost you incur to providement services qualifies as a working condition benefit if the benefit determines its FMV.you provide the services to the employee on the basis ofneed and you get a substantial business benefit from the Employer-provided vehicles. In general, the FMV of anservices distinct from the benefit you would get from the employer-provided vehicle is the amount the employeepayment of additional wages. Substantial business bene- would have to pay a third party to lease the same or similarfits include promoting a positive business image, maintain- vehicle on the same or comparable terms in the geo-ing employee morale, and avoiding wrongful termination graphic area where the employee uses the vehicle. Asuits. comparable lease term would be the amount of time the

Outplacement services do not qualify as a working con- vehicle is available for the employee’s use, such as adition benefit if the employee can choose to receive cash 1-year period.

Do not determine the FMV by multiplying aor taxable benefits in place of the services. If you maintaincents-per-mile rate times the number of miles driven un-a severance plan and permit employees to get outplace-less the employee can prove the vehicle could have beenment services with reduced severance pay, include in theleased on a cents-per-mile basis.employee’s wages the difference between the unreduced

severance and the reduced severance payments.Cents-Per-Mile Rule

Exclusion from wages. You can generally exclude thevalue of a working condition benefit you provide to an Under this rule, you determine the value of a vehicle youemployee from the employee’s wages. provide to an employee for personal use by multiplying the

standard mileage rate by the total miles the employeeException for independent contractors. You cannotdrives the vehicle for personal purposes. Personal use isexclude the value of parking or the use of consumer goodsany use of the vehicle other than use in your trade oryou provide in a product testing program from the compen-business. This amount must be included in the employee’ssation you pay to an independent contractor who performswages or reimbursed by the employee. For 2005, theservices for you. standa

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