The Nonreportng of Modern Fringe Benefits

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Today we welcome first-time guest bloggers Jay A. Soled and Kathleen DeLaney Thomas. Jay is a tax professor at Rutgers University, and Kathleen is a tax professor at the University of North Carolina School of Law. While in Procedurally Taxing we have discussed isolated issues relating to information reporting, in this post Jay and Kathleen discuss the pervasive failure of employers to report many types of fringe benefits. The authors have written a more expansive piece on the same issue entitled, Revisiting the Taxation of Fringe Benefits, that will appear shortly in a forthcoming issue of the Washington University Law Review. Les

Due to advances in technology and globalization of the work force, there is a whole new breed of fringe benefits that have emerged in the twenty-first century. While these fringe benefits come in many varieties, they generally can be grouped into three baskets: (i) customer loyalty award programs like frequent flyer miles and hotel points; (ii) the use of high tech gadgets and services such as cellphones and high-speed internet access; and (iii) on-the-job perks like lavish meals, dance lessons, and massages. While today’s office perks may bear little resemblance to the fringes of years past (think coffee in the break room and an annual holiday party), the tax treatment should be the same: that is, those fringe benefits not specifically exempted from taxation by Code section 132 are reportable and subject to payroll and income taxes. But there is a strange phenomenon transpiring with respect to this new breed of fringe benefits. While they generally do not fall within the delineated scope of Code section 132’s enumerated exemptions, they are nevertheless not being reported as income by employers (nor by the employees, who follow suit).

In the employer-employee context, the failure to report taxable income is particularly unusual. This is because an employer who fails to report employee remuneration (including taxable fringe benefits) faces stiff penalties. More specifically, under Code section 6721, the penalty for the failure to issue correct information returns can readily exceed $1 million, particularly for large companies with a lot of employees. Thus, when it comes to employee compensation, most employers err on the side of reporting lest they endure the risk of being severely penalized.


Despite this third-party reporting safeguard, the problem of fringe benefit nonreporting persists, plaguing the nation and potentially costing the fisc billions of dollars annually (albeit, hard-and-fast dollar revenue loss estimates are nettlesome to make). The most obvious question is why a problem that is so prevalent, of this magnitude, and in the public domain nevertheless persists. There are at least three probable reasons. First, compensating employees with untaxed fringe benefits in lieu of salary allows employers to circumvent their payroll tax obligations and thereby minimize their own tax burden. Second, since the advent of these newly-minted fringe benefits, employers have not reported their value as income and such nonfeasance has been met with impunity. Indeed, Congress has essentially ignored the issue while the IRS has signaled that it will not challenge employers’ nonreporting (see Announcement 2002-18 regarding frequent flyer miles and Notice 2011-72, regarding cell phones), giving employers every reason to continue their current practices. Third, employers might fear public outcry and media scrutiny if they were to shift gears and begin reporting such benefits absent some pronouncement from Congress, Treasury, or the IRS. This concern might not be unfounded, given the political firestorm that erupted when Citibank issued 1099s to customers who received free frequent flyer miles for opening new accounts. See, e.g., Alistair M. Nevius, Are Frequent Flyer Miles Taxable?, J. Acct. (Aug. 1, 2012). In light of these reasons, the fringe benefit nonreporting bonanza has and will continue for the foreseeable future.

Yet, having a tax system in which nonreporting is tacitly approved is inherently problematic. Indeed, some taxpayers may take the current state of affairs as a cue to further push the limits of what constitutes “nonreportable fringe benefits” or, alternatively, test the water and engage in other forms of nonreporting. Whatever the case, either taxpayer stance does not bode well for tax compliance and may result in enlarging the tax gap – the difference between what taxpayers owe in tax and what they pay.

To address this problem, action must be taken by Congress, not the IRS. Over the past several years, Congress has delivered mixed messages regarding the taxation of these twenty-first century fringe benefits. These mixed messages have put the IRS in an untenable position: if the agency takes enforcement action, it will be deemed to be too aggressive, and conversely, if it fails to take enforcement action, it will be perceived to be inept.

There are several approaches Congress could take to address the receipt of modern fringe benefits. First, it could decide that some or all of such benefits should be exempt from income and accordingly expand the scope of Code section 132. At the very least, this would mean Congress was no longer offering tacit approval of noncompliance; it would also delineate lines between taxable and nontaxable fringes in the modern era.

Second, Congress could specify that such benefits are includable in employees’ income at their fair market value. Under such an approach, Congress would be well-advised to adopt fixed valuation proxies for purposes of administrative ease. For example, the fair market value of all frequent flyer awards could be deemed to be equal to one cent per mile, and a fixed percentage of employer-provided cellphone use could be deemed personal in nature (say, 40%). Concerns about over-taxing employees could be mitigated by choosing proxy values that are on the low end of fair market value estimates, and by allowing taxpayers to “opt out” of taxation on mixed-use assets like cellphones by agreeing to utilize them for business purposes only.

Finally, Congress could deny employer deductions for all or a portion of the cost of these fringe benefits. For example, an employer who spends $100 on a masseuse that will provide an onsite massage to a stressed employee would only be able to deduct a portion of the cost (say, $50). This approach would be akin to the one taken by Code section 274(n), which limits the deductibility of business meals to 50 percent of the employer’s cost, thereby serving as a proxy tax on the benefit to the employee.

The new breed of twenty-first century fringe benefits requires an updating of the current tax regime. Congress should act and has several viable options to consider. What it should not do, however, is sit on its hands and permit taxpayers’ nonreporting practices to continue unchallenged.


  1. Sale and use tax provides a perfect historical example of what happens if reporting is left to taxpayers. The very large majority simply choose not to pay it. In that context as in this one, absent some sort of system that forces the provider to pay/collect/report the tax, nothing will change.

  2. Deborah Snow says

    Whether it is Congress or the IRS the taxation of Frequent Flyer Miles and other perks is stepping into quicksand. How is any government agency going to police these work perks? If you are a Million Miler with Delta and sit in First Class are your miles taxed at a different rate because you get a seat with more room, more padding, and a free drink? Yes, I read the article and the suggestion of one cent per mile is arbitrary: a miles coach ticket and a first class ticket are very different. How are we going to be taxed when the airline gives me Pre-Check and saves me time in the security line? That time saved equals money, how is that valued? How am I taxed when the airline at the last minute gives me a first class seat which I did not ask for?

    What about the holiday fruit cake that is given as a gift? The receiver does NOT want it; should they be taxed on a gift they did not want or ask for from their employer? What about gifting FF miles to a family member?

    And a masseuse? That’s a perk I’ve never seen in 35 years of business travel. You must get better benefits than I do. A blanket waiver on these small perks would be preferable to the huge cost burden that reporting them would impose on employers and employees.

    It would seem to me (a taxpayer) that Congress and the IRS time would be better spent taking care of current internal problems (Lois Lerner) and less time on the IRC. How many pages is it up to now?

    Please leave me and my fruit cake to fly the friendly skies in peace.

  3. Employers generally do not pay with FF miles. They pay for travel expenses and the travel industry uses awards to generate business. In some cases the employer earns and keeps miles from the financial industry for paying employee and other business expenses with credit cards.

    The whole system exposes the soft underbelly of our tax compliance efforts. But to suggest that “Congress should act” is to admit there is no solution. American Express and American Airlines lobbyists will never let it happen. And for that I am grateful as I start my day of tax-free snorkeling here on the Ningaloo Reef.

  4. Karma Chameleon says

    On a legal point, I challenge the good Professors’ premise that their described fringe benefits represent income in its constitutional sense.

    On a societal point, I believe the surviving Beatles and their late band members’ estates should re-release George Harrison’s “Tax Man” to the tune of “Tax Profs.”

    • In the same way that executives have brilliantly avoided income tax rates by paying themselves an artificially low salary and instead receiving compensation taxed as capital gains, what’s to stop someone from shifting a significant portion of compensation from income to “perks” to avoid taxes? Why stop at dry cleaning, free cafeterias, free shuttles, day care and company paid vehicles? One could envision company paid housing, groceries at home, toiletry “care packages”, vacation expenses, and a raft of other perks that virtually obviate the need for a large taxable salary.

      Tech giants offer some fairly costly perks. At what point is a fringe benefit not income?

  5. Perhaps a better theme would Paul and Linda McCartney’s band Wings “Band on the Run,” recorded in Nigeria to avoid UK taxes.

    If we are going to discuss airline miles, suggestions are welcome on how to report award travel by my clients who flew around the world with a stop in South Africa earlier this year, First Class including showers on (in?) an A380, using miles collected from various banks that issue various credit cards. For examples of how the game is played, see the blog recently profiled in Rolling Stone,

  6. The website I mentioned in the last post is a good source but this is the one featured in a Rolling Stone article (the blogger has some interesting comments about sloppy RS reporting):

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