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Lifestyle Spending Accounts


Christine Roberts

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Lifestyle spending accounts are a trending after-tax benefit consisting of employer after-tax reimbursement of lifestyle products and services such as personal coaching, fitness wear and gear,  pet boarding, personal training, etc. Employers choose a yearly maximum and only pay out documented reimbursement requests, up to the maximum limit.  Employer deducts reimbursed amounts as taxable compensation to employees.  Just wondering if anyone out there has formally classified this "benefit" as either a payroll practice, benefit plan, or addressed potential constructive receipt issues.  

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I am sorry I am not answering your question....

I just have to know who likes this idea as a benefit that is a "trending" benefit? 

Am I understanding how this works correctly?  Say we have employee A and employee B.  They both do the same job and get paid exactly the same in terms of salary and benefits except for this program.  A has a pet they board and B doesn't.  So A's W-2 will reflect a higher gross and taxable wages because of the reimbursement of the pet boarding?   If so, that means a person's total compensation is based on a personal choice to own and board a pet and not work place actions, is that correct? 

Like I said I am not answering your question at all so if you want to ignore me as I am being way off topic there will be no hurt feelings on my part.   This board collectively can hijack a topic and I am as guilty as the next person.  I am however curious about my questions enough to write them. 

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@Christine Roberts I agree, these are on the upswing. As soon as the FSA TPAs start offering it, you can tell there's at least a push to create a market for them.  I've heard from a couple clients that they are popular in Canada and that's why they're starting to be offered here.

My basic feeling is it doesn't really matter how you classify an LSA because it's not an ERISA benefit and it's not tax-advantaged.  So there is not set legal scheme we're trying to make it operate within.

The constructive receipt question is one where I think the IRS is going to have to weigh in at some point on both LSAs and employee rewards programs.  They both offer a bucket of funds (sometimes with a specific "coin of the realm" in the form of points that act as funds) that can be used or converted to purchase items.   

While there is an argument that the doctrine of constructive receipt should apply to make the amount available taxable (as opposed to the amount used/reimbursed), I have never seen an employer actually take that position in practice.  Every employer I have seen with this type of arrangement has made only the amount used/reimbursed taxable to the employee. 

But I agree that in theory the §451 constructive receipt rules seem to potentially apply to make the amount made available taxable.  This is the best post I've seen tackling that issue: https://www.thetaxadviser.com/issues/2011/jan/takacs-jan2011.html

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Brian, thanks for the comments and the link, and yes, like the Maple Leafs and poutine, LSAs originated in Canada.  ESOP Guy - I understand your viewpoint.  The roster of reimbursables for LSAs is long, so the pet-free employee can use their budget to purchase some $100 Lululemon yoga togs or get cosmetic dentistry.  FWIW.  

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I have reviewed these issues closely for a client within the LSA industry.  Whether the benefits are subject to ERISA and/or wellness regulations depends on what is being offered.  I have advised clients that the constructive receipt rules do apply, regardless of whether the employee uses/receives the entire amount available during the taxable year.  Basically, absent the use of a cafeteria plan (which is restricted to certain benefits) or a deferred compensation/retirement plan, employer-provided benefits are taxable once they are made available, unless they fall within a specific fringe benefit section of the Internal Revenue Code.  Finally, as you mentioned, employers tend to make a long list of items available for selection, so that it is not just pet owners, for example, who receive the bump in compensation.  I hope that helps.

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You people seem to be over thinking the example in the details and are missing the main point.

I find the idea that my compensation will be in part based on if I do behaviors my employer approves outside of work odd at best and offensive at worst. 

Who are they to judge if my idea of hobbies, ways to better myself, deciding to own a pet, other lifestyle choices I make.... are worthy enough of their approval seen by given cash to people?  

Just pay people and they can spend THEIR money as they see fit and stop making me go and find out if my employer approves of my spending/lifestyle or not.  

To get real blunt (if I haven't crossed that line already) I would find this benefit a negative.  I might not refuse to work for an employer that offered it but if I was making a list of good and bad things about the company as I was making a decision to work for them this would be on the bad list.  It points to the idea they are too paternalistic.  I don't mind a boss but I don't need nor want a new parent. 

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I haven’t looked at it from a tax perspective, but, seems to me that the better option would be to set up the same amount to everyone as a set of credits, as a dollar amount per capita, or a percent of pay.  Perhaps they can be “funded” by a traditional profit sharing award - tied to corporate, or team and/or individual performance.  Then, to the extent the individual dies not allocate them through the cafeteria plan to items eligible for tax preferred treatment, or to a 401k, they would be paid as wages - leaving choice and control up to the individual.  I don’t have them at hand, but I know there are behavioral economics studies showing improved engagement where individuals have choice and control - where outside of tax preferences, that is maximized as cash.

most importantly, I don’t want to be in the position as an employer, of making decisions on what qualifies.

By the way, I feel the same about taxable reimbursements of student debt - aren’t those folks already earning wages that reflect their skills, performance?  I don’t support any such items - but, if I had to, I would favor reimbursement to cover debts for those who did not graduate.

 

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  • 10 months later...
  • 9 months later...

I'm just coming to this issue for a client as well. 

I'm with ESOP Guy. Every sample list of approved benefits I've seen includes things like yoga and meditation classes.  I've not seen any that reimburse wood for the fire pit or fishing lures.  Some people meditate in different ways.  I get that employers may want to promote particular wellness benefits for a healthier (and thus more productive and otherwise cheaper) workforce but we have wellness programs with different regulations to do that.  The more these accounts encourage those expenses (which, frankly, seems to me the most defensible use of these) the closer I see them to ERISA plans that should be closely regulated.

Sheila, I'm curious if you are still providing legal support to the LSA vendor or if they decided they didn't like your advice.  So far, I have been unimpressed with the general guidance and analysis provided by the LSA vendors I've seen.

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I also have seen a lot of LSAs veer into ERISA group health plan status by including medical expenses that need to be removed.  But yoga and meditation are not problematic.  Those aren't §213(d) expenses.  And LSAs aren't designed as incentives or rewards that implicate the HIPAA/ACA/ADA wellness program regulations.  They're just straight reimbursements.

I did a webinar on this topic a couple weeks ago.  Here's a highlight of the main concern you're raising:

Newfront Office Hours Webinar: Fringe Benefits for Employers

image.png.4071ae1533573f1785c2694c25cb2c67.png

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I am also being asked to advise a large TPA firm who wants to jump into the LSA market. My independent research of IRS documents, before finding this page, also led me to believe that the benefit should be taxed when made available, rather than when a claim is reimbursed. However, as others have pointed out, the plethora of online providers marketing this "revolutionary benefit" universally say the employee isn't taxed under they use the money.

I can understand how, if the benefit was relatively small, the reimbursable events limited, and the benefit was use-it-or-lose-it, it would make sense that you wouldn't tax a person until they used it. For instance, if a plan only paid $50/month for physical fitness classes or gym memberships, lots of people won't use that benefit and they'll be quite angry if they are taxed for something they didn't want. However, with these LSA accounts being expanded to be used for darned near anything an employer can think of (new golf clubs or tickets to Hamilton anyone?), it makes more sense to tax when the money becomes available because there's really no reason to NOT use it.

Further, my client wants to make the LSA a funded account held in a VEBA, so in theory somebody could accumulate considerable money in that account, take it with them when they leave employment, etc. In this instance, this really does look like a deferred comp plan subject to 409A even if the employee might not ever turn in a claim for the money. That leaves to me wonder, what if somebody got $1,000/year for 10 years and never used it?  They've been taxed on it .... where does the money go? Back to the employer with the individual then taking a tax credit (as you would in a more standard deferred comp plan when it loses value over time?) Can you have a beneficiary?

Many thanks to Brian Gilmore who came to the same conclusions I did, but with much greater grace and style! I'm going to advise them to tax when funded and we'll see if they are successful selling such a product!

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Forgive the rant as it has been a long week.   But does the world really need these?  Or are they more a way for vendors to sell new "benefits"  What a nightmare to have to decide what counts and what does not and explain and then track this, especially if this evolves into a virtually anything counts sort of arrangement.  There is another, easier and more legal way to do that if employers really want to provide employees with the means to consume additional services or goods--it's called a raise.  Or maybe we could give it a new name / acronym to have more cache and call it an ASE (annual salary enhancement).

 

I have no idea if it is legal to do this in a VEBA but I can imagine that if a vendor rolls this sort of arrangement out and saddle employers with a VEBA to boot it will not be long before the employer will be calling for the vendor's head if they make any effort to administer the VEBA by the rules.

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I don't disagree with the rant - can we just call these "bonuses" and let employees spend the money the way they best see fit? If I'm going to buy pet insurance, I'm going to buy pet insurance. I don't want to have to involve paperwork and reimbursement procedures. Reminds me of the old Mitch Hedberg rant about giving you a receipt for a donut. (Mitch Hedberg - The donut joke - Bing video, you're welcome).

I argued against a VEBA company getting into the LSA market, I really did. Nobody funds these benefits - the selling point to employers is that this is a bonus that not everybody will use so it will be cheaper than giving everybody $1,000 cash, so why fund it? There's absolutely no tax benefit to involving a VEBA, and it adds a ridiculous amount of complexity to something that is already goofy to begin with.

However, if my client wants me to spend hours researching the constructive receipt doctrine and issues of deferred compensation, I'm going to do it so I'm thankful for this post.

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For those called to consider tax reporting about Lifestyle Spending Accounts:

There might be some difference between what an individual has constructively received (and should put in her Federal income tax return), and how much the employer/payer knows and must or should tax-report.

Could an employer have “reasonable cause” to report one or more boxes of Form W-2 wages counting only the LSA amounts paid?

Might an employer consider its particular arrangement’s terms and an employee’s circumstances and reason that the W-2 reporter might not know a particular employee has constructive receipt of an LSA-available amount? Some imagine an arrangement with a wide array of reimbursable items might result in every employee having constructive receipt up to the LSA’s maximum. But could there be an employee who, in the year a W-2 reports on, found no product or service on which to seek a payment or reimbursement? And until a particular employee claims her reimbursement or payment, how much does the employer know?

Depending on the LSA’s terms and other surrounding facts and circumstances, is it plausible, or at least arguable, that a particular employee (who is the subject of a W-2 report) neither paid nor incurred an expense for which the LSA provides a reimbursement or a payable, and that some portion of an LSA limit or sublimit was not “available” to the particular employee?

I have not considered the merits or weaknesses of any such reasoning. An employer might want its lawyer’s written advice, and might want it to be no less complete and careful than the practices described in 31 C.F.R. § 10.33.

Peter Gulia PC

Fiduciary Guidance Counsel

Philadelphia, Pennsylvania

215-732-1552

Peter@FiduciaryGuidanceCounsel.com

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6 hours ago, Jaeded said:

Many thanks to Brian Gilmore who came to the same conclusions I did, but with much greater grace and style! I'm going to advise them to tax when funded and we'll see if they are successful selling such a product!

Thanks for the nice comments, Jaeded.  I think the LSA constructive receipt issue here is a classic industry norm vs. technically correct conundrum with no right answer in how best to approach it. 

But as a TPA, I'm not sure your client needs to have the answer.  The TPA isn't taxing the benefit--that's the employer's role.  It seems to me the TPA can present both alternatives and let the employer choose.  The TPA will be performing the same administrative functions regardless.

The taxing reimbursement approach that is by far the most common in practice but still somewhat aggressive.  Or the taxing amounts made available that is probably the way the IRS would view it, but out of step with employee expectations and industry standards.  Then leave it up to the employer and their advisors to make the determination based on risk tolerance, etc.

Here's how I've tried to present the issue in a balanced way:

Newfront Office Hours Webinar: Fringe Benefits for Employers

image.png.9be7d3b8da9c09529f7809526e06f66d.pngimage.png.cfccfbc2479af424579f3ba595b7b742.png

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