Qualified Employee Discounts

This fringe benefit arises when you give employees (or their spouses and dependent children) a price reduction on property or services that you ordinarily sell to your customers or clients. However, discounts on personal property usually held for investment, such as stocks or bonds, and discounts on real property, such as buildings or land, are not qualified employee discounts.

Qualified employee discount limitation. Also, there is a limitation on the nontaxable amount of a qualified employee discount you can provide. For property, the nontaxable discount doesn't include any amount that is more than your gross profit percent times the price you charge customers for the property. The gross profit percent is based on all property offered to customers, including your employees that are customers, in the ordinary course of your type of business and your experience during the tax year immediately before the tax year in which the discount is available. To calculate the gross profit percent, subtract the total cost of the property from the total sales price of the property and divide your result by the total sales price of the property. For services, the nontaxable discount doesn't include any amount that is more than 20 percent of the price you charge customers for the service.

Assume all the merchandise in your store cost you about $132,000. The total sales price of all this merchandise is $150,000. Now, you recently gave your employee a $300 discount on merchandise that has a sales price of $1,000. You are now trying to determine whether any of that discount has to be included in the employee's wages for tax purposes. Based on the gross profit percentage calculation, you should take the sales price of all your merchandise ($150,000) and subtract out what this merchandise cost you ($132,000). Now, take this number ($150,000 - $132,000 = $18,000) and divide it by the sales price ($18,000/$150,000 = .12). This gives you a gross profit percentage of 12 percent (.12 x 100). Now you take the 12 percent and multiply it by the normal sales price of the merchandise you sold at a discount to your employee ($1,000 x 12%=$120). Subtract this number from the discount you gave your employee ($300 - $120 = $180). Since the discount you gave your employee is greater than that provided by the gross profit percentage calculation, you're going to have to include $180 as a taxable discount in the employee's wages.

Employee defined. For these purposes, the term employee includes:

• an individual currently employed by you
• an individual who stopped working for you because of retirement or disability
• a surviving spouse of an individual who died while working for you or who stopped working for you because of retirement or disability
• a partner who performs services for your partnership

Discrimination in favor of highly compensated employees. It's important to note that highly compensated employees can't exclude the value of no-additional-cost services and qualified employee discounts from their income unless the benefit is available to all employees or a group of employees defined under a reasonable classification that doesn't discriminate in favor of highly compensated employees.

A highly compensated employee is an employee who satisfies either of the following:

• was a 5 percent owner of the employer at any time during the current year or the preceding year, or
• received more than $115,000 in compensation from the employer during the preceding year (employers may use an additional qualification requiring employees to be in the top 20 percent of employees when ranked by compensation). The $115,000 threshold amount is for 2012 and 2013 (the threshold amount may be indexed annually for inflation).

If a benefit is discriminatory, the entire cost of the benefit (not just the discriminatory part) must be included in the income of highly compensated employees. It's clear that the IRS will allow either all or nothing when they offer you a break on paying tax on these fringe benefits — all your company's employees must benefit equally or you will receive no benefit.

As owner and president of J & C Sporting Goods Store, you are the only company employee entitled to a 40 percent discount on all merchandise. The rest of your employees are entitled to a 10 percent discount on merchandise purchases. Because of the 30 percent disparity in discount rates (40 percent - 10 percent), the IRS will not let you exclude any portion of the discount from your salary because it is discriminatory toward your employees who are not owners. Your employees, on the other hand will still continue to enjoy the 10 percent discount and it will not be treated as compensation to them.