Fringe benefits taxable to employees if limits exceeded
Issue: Your company offers employees a 40% discount on its services. Is this fringe benefit tax free for employees?
Answer:     No. To be a qualified employee discount, which is not taxable to employees, an employee discount on services cannot be more than 20% of the sales price. Thus, employees must include in gross income as wages the amount of the discount in excess of this limit. 

In general, for employee discounts to be offered on a tax-free basis to employees, the following rules must be met:
  • The property or services must be offered for sale to nonemployee customers in the ordinary course of the employer's line of business for whom the employee performs substantial services;
  • The discount must be offered directly by the company or indirectly through a third party;
  • The discount for property cannot exceed the employer's gross profit percentage, and for services, the discount cannot be more than 20% of the sales price;
  • The discount must be offered only to employees and to certain others;
  • The discount must meet certain nondiscrimination rules; and
  • The discount must meet "line of business" rules.

Employee discounts that do not qualify for exclusion from gross income (either because these conditions are not met or because the discount exceeds the discount limits) are considered compensation subject to income tax withholding, FICA and FUTA taxes.

Source: CCH® U.S. Master™ Employee Benefits Guide
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