How to cheat your way through the Internal Revenue Code
Inside knowledge is usually a good thing. Unless, of course, it’s cheating. Just ask the Houston Astros or the Boston Red Sox.
The tax code is a tricky document. It’s a long, uninspired document written in bureaucratese. Sort of like the infield fly rule. So in honor of spring training and the coming baseball season, we’re going to show you two key short cuts to understanding payroll taxes.
But, under no circumstances are we advocating that you cheat on your taxes. The Houston Astros may be keeping their World Series rings (OK, at least for now), thanks to a decision by Major League Baseball Commissioner Rob Manfred. The IRS isn’t quite that forgiving.
‘For the convenience of the employer’
This is an absolutely loaded phrase. Sometimes it’s referred to as “a substantial noncompensatory business reason” or a “condition of employment.” It arose long ago because the IRS figured out that there are lots of ways to compensate employees, in addition to cash salary.
To move an item into the nontaxable column requires a showing that, when all the various interests of all the various parties are balanced, the employer is the principal beneficiary, not employees. The shortlist includes:
- Meals: Meals can be provided tax-free if they’re provided for the employer’s convenience. Example: Hospitals provide meals so employees are available in emergencies. The IRS is deciding whether delivery services, like GrubHub, eviscerate this rule. It hasn’t come to any conclusion yet.
- Lodging: An employee who must live on-site, like, say, a manager at a beach resort, lives there as a condition of employment.
- Working at home: Employees work at home for their employer’s convenience if there’s no office space for them (on purpose) or they’re distance workers.
- Cell phones: Smartphones and similar devices (not computers) are in their own special category. While the convenience-of-the-employer rule still applies, the bar to satisfy it is very low. Basically, anything will qualify, as long as you don’t provide the latest iPhones to employees to entice them to sign on with your company (that would be a substantial compensatory business reason). But employees’ reimbursements can’t be arbitrary—employees should submit their bills to you.
There are, of course, exceptions. For example, you may provide employees with identity-theft protection services, which seems pretty personal, even if your company hasn’t been hacked.
You get the idea. So when someone in the C-suite or HR says they have an idea for a spanking new fringe, ask yourself whether it looks like the company is picking up a personal expense. If the answer seems to be yes, you must investigate further to determine whether it’s taxable.
The convenience-of-the-employer rule deals with fringes that are disguised as compensation. The business connection rule deals with compensation masquerading as business expense reimbursements. But the principal is the same—employees are reimbursed for their personal expenses, so the reimbursements are taxable.
Expenses employees incur must be connected to your business. In other words, employees must have paid or incurred deductible expenses while working for you. The key is the deductibility of the expenses:
✓ Buying a case of copy paper for the office
✓ Buying case of copy paper for employees who work at home at the employer’s convenience
✗ Buying a case of paper and giving it to your college kid so they’ll have paper for the semester
✗ Spouses accompanying employees on business trips or to dinners with clients.
What do you do if you see requests for reimbursements that look suspiciously like personal expenses? As tactfully as you can, you shut it down or tax it, because the IRS knows where and how to look for these items in audits.
We’ll be adding to this cheat sheet periodically. If you have any suggestions, send ’em along.