Fringe Benefits Issues

[erinak03]

I have a client whose plan defines compensation to not include taxable fringe benefits.  I learned today that one of the employees is paid a "taxable living expense allowance", which I believe qualifies as a fringe benefit.  He was permitted to defer from (and be matched on) the allowance throughout 2018, and I imagine most of 2019.  I can deal with the excess match contributed but my question is if there is a "fix" for the failure as it pertains to the deferrals.  I'll need to confirm with the client if the allowance is paid with his salary in the same paycheck (which would mean his 15% deferral election was actually a higher rate of deferral based on the lower eligible wage) or if it's done in a separate monthly check (in which case there shouldn't have been deferred from at all).  Do I just document as an operational failure, implement new procedures, lecture the client and move on?  The participant was clearly content with the deferrals as they were being withheld so I don't think a corrective distribution is the appropriate path as it would be a detriment to the participant.  Thanks in advance for your thoughts.

[Larry Starr]

Hmmmm.. first, what kind of job does he has that produces a living expense allowance?

Second, would the actual dollar amount contributed have been allowed on his allowable compensation if he had made a fixed dollar or higher percentage allowance (in other words, could the amount actually contributed be justified on the lower comp)?

 

[erinak03]

He's an "environmental assessor", from what I can tell.  The payroll item references travel expenses so I imagine it is akin to taxable per diem.

His salary alone is roughly $110k with an additional $13k in fringe benefits and he deferred the maximum in 2018.  He definitely wouldn't have run into any limit issues had the fringe benefits correctly been excluded, fortunately.  It comes down to either: 1) the plan sponsor withheld 16.75% of pay instead of the 15% requested on the election form; or 2) they withheld 15% on the paychecks they shouldn't have (if the taxable fringe was done in a completely separate paycheck).

I'm leaning towards simply leaving the deferrals as-is, documenting the error, having the plan sponsor inform the participant of the change to future checks (to correct the current method), and using the correct compensation for the matching contribution.  I'm just curious if there is anything glaring that suggests this is not the best route.

Thanks.

[Larry Starr]

Sorry, but I am not willing on the above information to come to a conclusion on this issue.

There is no such thing defined that I can find called "living expense allowance", taxable or not.  Now you say it's somehow related to "travel expenses".  Travel expenses is a deductible expense to the business and not taxable to the employee if they are reimbursements for allowable expenses (taxi, airplane, hotel, gas, etc. etc.).  What the heck is this EXACTLY?

Are they subjecting this extra money to withholding?  Are they paying SS taxes on it?  It may not be a fringe benefit.  

What exactly is the language in the plan that excluded fringe benefits?  Does it define the fringe benefits that are excluded (or does it provide a list of which ones they are)?

How are these amounts being reflected on the W-2?  Is it lumped in with the regular wages or is it something else?

I would want more information on this animal. Exactly what it is?  How is it determined for each paycheck?  Does he have to submit expense account statements or something?  

I think it is premature to automatically assume that they are right about it being a "fringe benefit" that is excluded.  Maybe it is, but we don't have enough information to make sure of that at this point.

 

[erinak03]

Okay, I got additional details from the employer.  It is a housing allowance that is considered a taxable fringe benefit as it does not qualify for a "for the convenience of the employer" exemption.  It is subject to federal income tax and FICA taxes as well so it sounds like it's being handled correctly per IRS Pub 15-B.

The relevant part of the plan compensation definition: "Compensation" means a Participant's Basic Compensation, adjusted by this Section, actually paid during the Compensation Computation Period, adjusted as follows: (a) excluding (even if includible in gross income) reimbursements or other expense allowances, fringe benefits (cash or noncash), moving expenses, deferred compensation, and welfare benefits... 

In further conversation with the client, they switched payroll processors in 2019 and the current processor is correctly excluding the housing allowance in all deferral and matching calculations so my issue is really just tackling the error from 2018 and early 2019.

Thanks Larry, I appreciate the conversation.

[Larry Starr]

48 minutes ago, erinak03 said:

Okay, I got additional details from the employer.  It is a housing allowance that is considered a taxable fringe benefit as it does not qualify for a "for the convenience of the employer" exemption.  It is subject to federal income tax and FICA taxes as well so it sounds like it's being handled correctly per IRS Pub 15-B.

The relevant part of the plan compensation definition: "Compensation" means a Participant's Basic Compensation, adjusted by this Section, actually paid during the Compensation Computation Period, adjusted as follows: (a) excluding (even if includible in gross income) reimbursements or other expense allowances, fringe benefits (cash or noncash), moving expenses, deferred compensation, and welfare benefits... 

In further conversation with the client, they switched payroll processors in 2019 and the current processor is correctly excluding the housing allowance in all deferral and matching calculations so my issue is really just tackling the error from 2018 and early 2019.

Thanks Larry, I appreciate the conversation.

OK; given that information, I would agree that it would count as "fringe benefits" and would not be included.  So now, you just have to deal with the correction, and I will let others opine on that process.

You asked this in the original posting:  Do I just document as an operational failure, implement new procedures, lecture the client and move on? 

I would do as you suggest, and also have the participant elect a fixed dollar amount deferral that approximates what he wants as the deferral percentage that would include the fringe benefit in the calculation.

[Luke Bailey]

There is no real definition of the term "fringe benefits" for tax purposes. If the $13k is based at all on his actual expenses, e.g. could be more if his expenses go higher or less if lower, and if the employer views it as a "fringe benefit" and has a consistent policy to do so, then it's probably a "fringe benefit." But if it's a negotiated amount, it could just be additional comp that the employee rationalized based on living expenses. Bottom line, the employer needs to adopt an interpretive policy and be consistent, but it could probably go either way.

[Larry Starr]

20 hours ago, Luke Bailey said:

There is no real definition of the term "fringe benefits" for tax purposes. If the $13k is based at all on his actual expenses, e.g. could be more if his expenses go higher or less if lower, and if the employer views it as a "fringe benefit" and has a consistent policy to do so, then it's probably a "fringe benefit." But if it's a negotiated amount, it could just be additional comp that the employee rationalized based on living expenses. Bottom line, the employer needs to adopt an interpretive policy and be consistent, but it could probably go either way.

No disagreement.  I made my conclusion NOT on fringe benefit exclusion, but on the first clause in the definition: excluding (even if includible in gross income) reimbursements or other expense allowances.

[Luke Bailey]

7 hours ago, Larry Starr said:

No disagreement.  I made my conclusion NOT on fringe benefit exclusion, but on the first clause in the definition: excluding (even if includible in gross income) reimbursements or other expense allowances.

Right. I mean, with "taxable fringe benefits" the distinction between that and pay can be pretty subtle. On the one hand you have something that won't be paid unless it is incurred, e.g. an employer that will reimburse moving expenses. At the other extreme you have an employer that has an office in an expensive area and pays everyone working in that office a $10,000 "living expenses" bonus vs. what it pays in other offices. There are probably things in between as well. It all goes in Box 1 of the W-2, so if for some crazy reason an employer wants to depart from the simplicity of the W-2 safe harbor for 414(s) and say that comp does not include "taxable fringe benefits," it really needs to go through all its payroll codes and specify which codes are fringe benefits, which not.