Vacation Time A taxable fringe??

[austin3515]

I have a client who is trying to argue with me that vacation is a taxable fringe benefit and thus not eligible for contributions based on their plan provisions (which do exclude taxable fringe). I know it's ridiculous but its hard to point to something concrete...

[buckaroo]

Thee possible options:

1) Tell them to confirm their opinion with their accountant and legal counsel.

2) Point them to Publication 15B Employer's Tax Guide to Fringe Benefits and ask them where it addresses compensation for vacation as a taxable fringe benefit.

3) Tell them that if they want to exclude compensation for vacation that they should amend the plan document to do so and inform them that they would be subject to 414(s) testing.

[austin3515]

Option 4 of course would have been to prove beyond any doubt that they were wrong. I was hoping this maybe addressed at an IRS QA or something. The problem is, it is not a ridiculous position. IT might be widely accepted by us pension geeks as not ok, but to an ordinary intelligent person, it's a benefit just like anything else - they're getting paid for NOT working. Sounds like a benefit. Again, I disagree with the position, but it's always harder to dispossess people of positions and interpretations that are grounded in sound logic!

[My 2 cents]

Vacation pay is ordinary income, subject to OASDI taxation, etc. How could it possibly be treated as a fringe benefit for tax and pension purposes?

[austin3515]

Well, all taxable fringes are subject to OASDI so I'm not sure I get your logic?

[hr for me]

Haven't seen a client do it, but I agree they need to amend their plan, not because it is a fringe benefit, but because it needs to be excluded elsewhere if that is what they want to do.

From a payroll/timekeeping side, it seems like it could become a nightmare of epic proportions unless they have a very clean streamlined PTO system with very few edits.

I am not sure I would argue TxFrBnfts, but I would ask the "why do they want to exclude compensation during PTO?" question to see if there is a solution there. Is it because they want to lower their employer match? Do they stop other benefits during PTO (health insurance coverage, life insurance, Workers Comp, STD/LTD)? I suspect all those answers are NO. So why this one?

[austin3515]

Pet peeve: Someone asks if something can be done or how to treat something and it gets side tracked into "why does the client want to do such a thing anyway"?

If I wanted to know WHY a client wanted to do something, I wouldn't ask you all - I would ask the client!

Laughing as I'm typing but had to vent...

[jpod]

I feel your pain, Austin. Fringe benefits may be excluded using a 414(s) safe harbor. It is impossible to believe that the IRS had salary for time not worked (vacation pay or employer-paid sick pay) in mind when they used the term "fringe benefit" in that safe harbor. If I were being paid to research this thoroughly I bet I could find at least a hint of this, but nothing comes to mind off the cuff.

[BG5150]

Thee possible options:

1) Tell them to confirm their opinion with their accountant and legal counsel.

2) Point them to Publication 15B Employer's Tax Guide to Fringe Benefits and ask them where it addresses compensation for vacation as a taxable fringe benefit.

3) Tell them that if they want to exclude compensation for vacation that they should amend the plan document to do so and inform them that they would be subject to 414(s) testing.

I just searched the publication and it mentions vacations only twice: as an award or unavailability of an automobile if the ee is on vacation.

[Lou S.]

Because the DOL says you have to count vacation hours?

[austin3515]

What does counting hours have to do with the question?

[hr for me]

Sorry if I took your question off track. My brain tends to go beyond the basic benefit question to the larger HR consulting questions. I've been trained on the HR consulting side of benefits to sometimes go to the larger question to help solve the specific question asked. I'll be sure not to respond this way to you in the future. If I don't have the specific answer, I won't brainstorm how to work around it a different way since this is your pet peeve.

[austin3515]

hey we can both respond however we choose! This a democratic society!

[Judym]

I found this while researching the same question:

Treas. Reg. section 31.3401(a)-1(b)(3) 
Vacation allowances. Amounts of so-called “vacation allowances” paid to an employee constitute wages. Thus, the salary of an employee on vacation, paid notwithstanding his absence from work, constitutes wages.

[Paul I]

Please see https://www.irs.gov/businesses/small-businesses-self-employed/employee-benefits where the IRS says:

"Fringe Benefits

A fringe benefit is a form of pay for the performance of services. For example, you provide an employee with a fringe benefit when you allow the employee to use a business vehicle to commute to and from work.

Fringe benefits are generally included in an employee's gross income (there are some exceptions). The benefits are subject to income tax withholding and employment taxes. Fringe benefits include cars and flights on aircraft that the employer provides, free or discounted commercial flights, vacations, discounts on property or services, memberships in country clubs or other social clubs, and tickets to entertainment or sporting events."

The Department of Labor notes here https://www.dol.gov/general/topic/benefits-leave/vacation_leave that:

The Fair Labor Standards Act (FLSA) does not require payment for time not worked, such as vacations, sick leave or federal or other holidays. These benefits are matters of agreement between an employer and an employee (or the employee's representative).

And note https://www.law.cornell.edu/cfr/text/2/200.431 comments:

§ 200.431 Compensation - fringe benefits.

(a) General. Fringe benefits are allowances and services provided by employers to their employees as compensation in addition to regular salaries and wages. Fringe benefits include, but are not limited to, the costs of leave (vacation, family-related, sick or military), employee insurance, pensions, and unemployment benefit plans. Except as provided elsewhere in these principles, the costs of fringe benefits are allowable provided that the benefits are reasonable and are required by law, non-Federal entity-employee agreement, or an established policy of the non-Federal entity.

 

Literature searches will find many references saying the term "fringe benefits" is not defined.  It seems the definition of what are or are not fringe benefits is based on the employer's and employees' common understanding of what that term means to the them (e.g. the DOL quote that they are "matters of agreement between an employer and an employee"). 

Much of the work we do involves defining how compensation is defined for various plan purposes such as calculating benefits, applying dollar limit, testing for nondiscrimination, and a myriad of other things.  In all, there is something like 14 or so different definitions available for use in retirement plans.  Much of what is common among these definitions is based on what the IRS considers taxable income, and we spend a lot of time setting plans to allow plan participants to not have to pay taxes on amounts set aside currently for their retirement.  We see vacation in the category pay earned as a reward to performance of services and vacation pay as an integral part of annual compensation, but vacation in the eyes of the IRS is pay for time related for non-performance of services (to borrow from the definition of hours of service) and is a fringe benefit.  The DOL reinforces that concept by noting employers do not have to pay employees for any vacation.

[Belgarath]

Hi Paul - it is interesting, but the current language of 200.431 doesn't include the word "vacation." I know this only because I just had to look it up as we just received a question on this. Here it is. Emphasis is mine. I note that (b) does leave room for interpretation...

§ 200.431 Compensation—fringe benefits.

(a) General. Fringe benefits are allowances and services employers provide to their employees as compensation in addition to regular salaries and wages. Fringe benefits include, but are not limited to, the costs of leave, employee insurance, pensions, and unemployment benefits. Except as provided elsewhere in these principles, the costs of fringe benefits are allowable provided that the benefits are reasonable and are required by law, an organization-employee agreement, or an established policy of the recipient or subrecipient.

(b) Leave. The cost of fringe benefits in the form of regular compensation paid to employees during periods of authorized absences from the job, such as for annual leave, family-related leave, sick leave, holidays, court leave, military leave, administrative leave, and other similar benefits, are allowable if all of the following criteria are met:

(1) They are provided under established written leave policies;

(2) The costs are equitably allocated to all related activities, including Federal awards; and,

(3) The accounting basis (cash or accrual) selected for costing each type of leave is consistently followed by the recipient or subrecipient or a specified grouping of employees.

(i) When a recipient or subrecipient uses the cash basis of accounting, the cost of leave is recognized in the period that the leave is taken and paid for. Payments for unused leave when an employee retires or terminates employment are allowable in the year of payment and should be allocated as a general administrative expense to all activities or included in the fringe benefit rate.

(ii) The accrual basis may be only used for those types of leave for which a liability as defined by GAAP exists when the leave is earned. When a recipient or subrecipient uses the accrual basis of accounting, allowable leave costs are the lesser of the amount accrued or funded.

[Paul I]

@Belgarath thanks for sharing what you found recently.  It is an opportunity to review and refresh the post from 2023 with what has or hasn't changed, and being January when companies are scrambling to issue W-2 makes it all the more relevant.

 

Section 200.431 is an example of how fringe benefits have been defined by a federal agency.  This section in particular deals with what the government will reimburse a company for employee compensation where the company is awarded a federal contract.  Section 200.431 was amended in April 2024 (https://www.govinfo.gov/content/pkg/FR-2024-04-22/pdf/2024-07496.pdf#page=91) and again in October 2024 (https://www.govinfo.gov/content/pkg/FR-2024-10-01/pdf/2024-22520.pdf#page=2).  As you noted, "vacation" among other examples was removed from the text and the text relies on the use of "leave".  This is not surprising because "leave" is used generically across the federal government and the military to describe paid time off.

The reference to the DOL https://www.dol.gov/general/topic/benefits-leave/vacation_leave continues to follow the path Home -> Leave Benefits -> Vacations and essentially notes that FLSA does not require paid time off for vacation, holidays, and sick leave, and a being paid for this time off is negotiable between the employee and employer.  I believe that the takeaway from this reference is if the employer and employee agreed on terms for paid time off, than that pay is a fringe benefit.  If the employee is not paid for time off, then it is not a fringe benefit.  The importance here is, unlike many other fringe benefits, "vacation" as a fringe benefit is not automatically imputed as compensation but rather is determined by an explicit agreement between employer, and employee whether the employer pays the employee for the time the employee was on vacation.

The IRS site https://www.irs.gov/businesses/small-businesses-self-employed/employee-benefits continues to list vacations is its list of fringe benefits.

[Belgarath]

Thanks Paul. Yeah, we dump this back on the client, to determine (hopefully) with their tax counsel. Then they tell us. This gets way into the realm of individual tax/legal advice, which my designations don't permit. I will say that generally, in my limited experience with this specific question, rightly or wrong the answer is "no, this isn't a fringe benefit." I have my doubts that the client has in fact asked tax counsel, but that's not my problem.