US Internal Revenue Service: p535--1999

8/14/2019 US Internal Revenue Service: p535--1999

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ContentsImportant Changes for 1999 ............. 1

Important Changes for 2000 ............. 2

1. Deducting Business Expenses .. 2

2. Employees' Pay ........................... 5

3. Meals and Lodging Furnished toEmployees ................................... 8

4. Fringe Benefits ............................ 9

5. Employee Benefit Programs ...... 17

6. Retirement Plans ......................... 20

7. Rent Expense .............................. 24

8. Interest ......................................... 26

9. Taxes ............................................ 32

10. Insurance ..................................... 33

11. Costs You Can Deduct orCapitalize ...................................... 36

12. Amortization ................................ 40

13. Depletion ...................................... 47

14. Business Bad Debts ................... 51

15. Electric and Clean-Fuel Vehicles 53

16. Other Expenses ........................... 57

17. How To Get More Information ... 63

Index .................................................... 65

IntroductionThis publication discusses common business

expenses and explains what is and is notdeductible. The general rules for deductingbusiness expenses are discussed in theopening chapter. The chapters that followcover specific expenses and list other publi-cations and forms you may need.

Important Changesfor 1999The following items highlight some changesin the tax law for 1999.

Standard mileage rate. The standard mile-age rate for the cost of operating your car,van, pickup, or panel truck in 1999 is 321/2cents a mile for all business miles driven be-fore April 1. The rate is 31 cents a mile forbusiness miles driven after March 31. Seechapter 16.

Health insurance deduction for the self-employed. For 1999, this deduction in-creases to 60% of the amount you paid forhealth insurance for yourself and your family.After 2001, the deduction will increase again.See chapter 10.

Business use of your home. You may beable to deduct expenses for your home officeeven if it is not where you perform your most

Departmentof theTreasury

InternalRevenueService

Publica tion 535Cat. No. 15065Z

BusinessExpenses

For use in preparing

1999 Returns


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important business activities or spend mostof your business time. See chapter 1.

Photographs of missing children. TheInternal Revenue Service is a proud partnerwith the National Center for Missing and Ex-ploited Children. Photographs of missingchildren selected by the Center may appearin this publication on pages that would other-wise be blank. You can help bring thesechildren home by looking at the photographsand calling 1800THELOST (1800843

5678) if you recognize a child.

Important Changesfor 2000The following items highlight some changesin the tax law for 2000.

Standard mileage rate. The standard mile-age rate for the cost of operating your car,van, pickup, or panel truck in 2000 is 32.5cents per mile for each business mile.

Meal expense deduction subject to hours

of service limits. For 2000, this deductionincreases to 60% of the reimbursed mealsyour employees consume while they aresubject to the Department of Transportation'shours of service limits. See chapter 16.

Taxable income limit for certain percent-age depletion. For tax years beginning after1999, percentage depletion on the marginalproduction of oil or natural gas is limited totaxable income from the property figuredwithout the depletion deduction. See chapter13.

1.

DeductingBusinessExpenses

IntroductionThis chapter covers the general rules for de-ducting business expenses. Business ex-penses are the costs of carrying on a tradeor business. These expenses are usuallydeductible if the business is operated to makea profit.

TopicsThis chapter discusses:

What can be deducted

How much can be deducted

When to deduct

Not-for-profit activities

Useful ItemsYou may want to see:

Publication

334 Tax Guide for Small Business

463 Travel, Entertainment, Gift, andCar Expenses

525 Taxable and Nontaxable Income

529 Miscellaneous Deductions

536 Net Operating Losses

538 Accounting Periods and Methods

542 Corporations

547 Casualties, Disasters, and Thefts(Business and Nonbusiness)

587 Business Use of Your Home(Including Use by Day-Care Pro-viders)

925 Passive Activity and At-Risk Rules

936 Home Mortgage InterestDeduction

946 How To Depreciate Property

Form (and Instructions)

Sch A (Form 1040) Itemized De-ductions

5213 Election To PostponeDetermination as To Whether thePresumption Applies That anActivity Is Engaged in for Profit

See chapter 17 for information about get-ting publications and forms.

What CanBe Deducted?To be deductible, a business expense mustbe both ordinary and necessary. An ordinaryexpense is one that is common and acceptedin your trade or business. A necessary ex-pense is one that is helpful and appropriatefor your trade or business. An expense doesnot have to be indispensable to be considerednecessary.

It is important to separate business ex-penses from the following.

1) The expenses used to figure the cost ofgoods sold.

2) Capital expenses.

3) Personal expenses.

TIPIf you have an expense that is partlyfor business and partly personal,separate the personal part from the

business part.

Cost of Goods SoldIf your business manufactures products orpurchases them for resale, some of your ex-penses are for the products you sell. You usethese expenses to figure the cost of the goodsyou sold during the year. You deduct thesecosts from your gross receipts to figure yourgross profit for the year. You must maintaininventories to be able to determine your costof goods sold. If you use an expense to figure

the cost of goods sold, you cannot deduct itagain as a business expense.

The following are types of expenses thatgo into figuring cost of goods sold.

The cost of products or raw materials inyour inventory, including the cost of hav-ing them shipped to you.

The cost of storing the products you sell.

Direct labor costs (including contributionsto pension or annuity plans) for workerswho produce the products.

Factory overhead expenses.

Under the uniform capitalization rules, youmay have to include certain indirect costs ofproduction and resale in your cost of goodssold. Indirect costs include rent, interest,taxes, storage, purchasing, processing, re-packaging, handling, and administrativecosts. This rule on indirect costs does notapply to personal property you acquire forresale if your average annual gross receipts(or those of your predecessor) for the pre-ceding 3 tax years are not more than $10million.

For more information, see the following.

Cost of goods soldchapter 6 of Publi-cation 334.

InventoriesPublication 538.

Uniform capitalization rulessection1.263A of the regulations.

Capital ExpensesYou must capitalize, rather than deduct, somecosts. These costs are a part of your invest-ment in your business and are called capitalexpenses. There are, in general, three typesof costs you capitalize.

1) Going into business.

2) Business assets.

3) Improvements.

Recovery. Although you generally cannottake a current deduction for a capital ex-pense, you may be able to take deductionsfor the amount you spend through a methodof depreciation, amortization, or depletion.These methods allow you to deduct part ofyour cost each year over a number of years.In this way you are able to recover yourcapital expense. See Amortization (chapter12) and Depletion (chapter 13) in this publi-cation. For information on depreciation, seePublication 946.

Going Into BusinessThe costs of getting started in business, be-fore you actually begin business operations,are capital expenses. These costs may in-clude expenses for advertising, travel, orwages for training employees.

If you go into business. When you go intobusiness, treat all costs you had to get yourbusiness started as capital expenses.

Usually you recover costs for a particularasset through depreciation. Generally, youcannot recover other costs until you sell thebusiness or otherwise go out of business.However, you can choose to amortize certaincosts for setting up your business. See GoingInto Business in chapter 12 for more infor-mation on business start-up costs.

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If you do not go into business. If you arean individual and your attempt to go intobusiness is not successful, the expenses youhad in trying to establish yourself in businessfall into two categories.

1) The costs you had before making a de-cision to acquire or begin a specificbusiness. These costs are personal andnondeductible. They include any costsincurred during a general search for, orpreliminary investigation of, a businessor investment possibility.

2) The costs you had in your attempt toacquire or begin a specific business.These costs are capital expenses andyou can deduct them as a capital loss.

If you are a corporation and your attemptto go into a new trade or business is notsuccessful, you may be able to deduct allinvestigatory costs as a loss.

The costs of any assets acquired duringyour unsuccessful attempt to go into businessare a part of your basis in the assets. Youcannot take a deduction for these costs. Youwill recover the costs of these assets whenyou dispose of them.

Business AssetsThe cost of any asset you use in your busi-ness is a capital expense. There are manydifferent kinds of business assets, such asland, buildings, machinery, furniture, trucks,patents, and franchise rights. You must capi-talize the full cost of the asset, includingfreight and installation charges.

If you produce certain property for use inyour trade or business, capitalize the pro-duction costs under the uniform capitalizationrules. See section 1.263A2 of the regu-lations for information on those rules.

ImprovementsThe costs of making improvements to a

business asset are capital expenses, if theimprovements add to the value of the asset,appreciably lengthen the time you can use it,or adapt it to a different use. You can deductrepairs that keep your property in a normalefficient operating condition as a businessexpense.

Improvements includenew electric wiring,a new roof, a new floor, new plumbing,bricking up windows to strengthen a wall, andlighting improvements.

Restoration plan. Capitalize the cost of re-conditioning, improving, or altering yourproperty as part of a general restoration planto make it suitable for your business. Thisapplies even if some of the work would byitself be classified as repairs.

Replacements. You cannot deduct the costof a replacement that stops deterioration andadds to the life of your property. Capitalizethat cost and depreciate it.

Treat amounts paid to replace parts of amachine that only keep it in a normal operat-ing condition like repairs. However, if yourequipment has a major overhaul, capitalizeand depreciate the expense.

Capital or Deductible ExpensesTo help you distinguish between capital anddeductible expenses, several different itemsare discussed below.

Business motor vehicles. You usuallycapitalize the cost of a motor vehicle you buyto use in your business. You can recover itscost through annual deductions for depreci-ation.

There are dollar limits on the depreciationyou may claim each year on passenger au-tomobiles used in your business. See Publi-cation 463.

Repairs you make to your business vehi-cle are deductible expenses. However,amounts you pay to recondition and overhaula business vehicle are capital expenses.

Roads and driveways. The costs of buildinga private road on your business property andthe cost of replacing a gravel driveway witha concrete one are capital expenses you maybe able to depreciate. The cost of maintain-ing a private road on your business propertyis a deductible expense.

Tools. Unless the uniform capitalization rulesapply, amounts spent for tools used in yourbusiness are deductible expenses if the toolshave a life expectancy of less than one year.

Machinery parts. Unless the uniform cap-italization rules apply, the cost of replacingshort-lived parts of a machine to keep it in

good working condition and not to add to itslife is a deductible expense.

Heating equipment. The cost of changingfrom one heating system to another is a cap-ital expense and not a deductible expense.

Personal ExpensesGenerally, you cannot deduct personal, living,or family expenses. However, if you have anexpense for something that is used partly forbusiness and partly for personal purposes,divide the total cost between the businessand personal parts. You can deduct as abusiness expense only the business part.

For example, if you borrow money and

use 70% of it for business and the other 30%for a family vacation, generally you can de-duct as a business expense only 70% of theinterest you pay on the loan. The remaining30% is personal interest that is not deductible.See chapter 8 for information on deductinginterest and the allocation rules.

Business use of your home. If you use partof your home in your business, you may beable to claim part of the expenses of main-taining your home as a business expense.These expenses include mortgage interest,insurance, utilities, repairs, and depreciation.

The business use of your home must meetspecific requirements before you can take anyof these expenses as business deductions.

To qualify to claim expenses for the busi-ness use of your home, you must meet thefollowing tests.

1) Your use of the business part of yourhome must be:

a) Exclusive,

b) Regular,

c) For your trade or business, AND

2) The business part of your home must beoneof the following:

a) Your principal place of business,

b) A place where you meet or dealwith patients, clients, or customers

in the normal course of your tradeor business, or

c) A separate structure (not attachedto your home) you use in con-nection with your trade or business.

You do not have to meet the exclusive usetest if you use part of your home in either ofthe following ways.

1) For the storage of inventory or productsamples.

2) As a day-care facility.

Beginning in 1999, your home office willqualify as your principal place of business ifyou meet the following requirements.

1) You use the office exclusively and regu-larly for administrative or managementactivities of your trade or business.

2) You have no other fixed location whereyou conduct substantial administrativeor management activities of your tradeor business.

For more information, see Publication 587.

Business use of your car. If you use your

car in your business, you can deduct car ex-penses. If you use your car for both businessand personal purposes, you must divide yourexpenses based on mileage. Only your ex-penses for the miles you drove the car forbusiness are deductible as business ex-penses.

You can deduct actual car expenses,which include depreciation (or lease pay-ments), gas and oil, tires, repairs, tune-ups,insurance, and registration fees. Instead offiguring the business part of these actual ex-penses, you may be able to use the standardmileage rate to figure your deduction. For1999, the standard mileage rate is 321/2 centsa mile for all business miles driven beforeApril 1. The rate is 31 cents a mile after March31.

If you are self-employed, you can alsodeduct the business part of interest on yourcar loan, state and local personal property taxon the car, parking fees, and tolls, whetheror not you claim the standard mileage rate.You can use the nonbusiness part of thepersonal property tax to determine your de-duction for taxes on Schedule A (Form 1040)if you itemize your deductions.

For more information on car expenses andthe rules for using the standard mileage rate,see Publication 463.

How Much

Can Be Deducted?You cannot deduct more for a business ex-pense than the amount you actually spend.There is usually no other limit on how muchyou can deduct if the amount is reasonable.However, if your deductions are large enoughto produce a net business loss for the year,the amount of tax loss may be limited.

Recovery of amount deducted. If you re-cover part of an expense in the same tax yearfor which you have claimed a deduction, re-duce your expense deduction by the amountof the recovery. If you have a recovery in alater year, include the recovered amount inincome. However, if part of the deduction for

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the expense did not reduce your tax, you donot have to include all the recovery in income.Exclude an amount equal to the part that didnot reduce your tax.

For more information on recoveries andthe tax benefit rule, see Publication 525.

Payments in kind. If you provide servicesto pay a business expense, the amount youcan deduct is the amount you spend to pro-vide the services. It is not what you wouldhave paid in cash.

Similarly, if you pay a business expensein goods or other property, you can deductonly the amount the property costs you. Ifthese costs are included in the cost of goodssold, do not deduct them as a business ex-pense.

Limits on losses. If your deductions for aninvestment or business activity are more thanthe income it brings in, you have a net loss.There may be limits on how much, if any, ofthe loss you can use to offset income fromother sources.

Not-for-profit limits. If you do not carryon your business activity with the intention ofmaking a profit, you cannot use a loss fromit to offset other income. See Not-for-ProfitActivities, later.

At-risk limits. Generally, a deductibleloss from a trade or business or otherincome-producing activity is limited to the in-vestment you have at risk in the activity. Youare at risk in any activity for the followingitems.

1) The money and adjusted basis of prop-erty you contribute to the activity.

2) Amounts you borrow for use in the ac-tivity if:

a) You are personally liable for repay-ment, or

b) You pledge property (other thanproperty used in the activity) as se-curity for the loan.

For more information, see Publication 925.Passive activities. Generally, you are in

a passive activity if you have a trade or busi-ness activity in which you do not materiallyparticipate during the year, or a rental activity.Deductions from passive activities generallycan only offset your income from passive ac-tivities. You cannot deduct any excess de-ductions against your other income. In addi-tion, you can take passive activity credits onlyfrom tax on net passive income. Any excessloss or credits are carried over to later years.For more information, see Publication 925.

Net operating loss. If your deductionsare more than your income for the year, youmay have a net operating loss. You can use

a net operating loss to lower your taxes inother years. See Publication 536 for more in-formation. See Publication 542 for informationabout net operating losses of corporations.

When Canan ExpenseBe Deducted?When an expense can be deducted dependson your accounting method. An accountingmethod is a set of rules used to determinewhen and how income and expenses are re-

ported. The two basic methods are the cashmethod and an accrual method.

For more information on accountingmethods, see Publication 538.

Cash method. Under the cash method ofaccounting, you deduct business expenses inthe tax year you actually paid them, even ifyou incur them in an earlier year.

Accrual method. Under an accrual methodof accounting, you generally deduct business

expenses when you become liable for them,whether or not you pay them in the sameyear. All events that set the amount of theliability must have happened, and you mustbe able to figure the amount of the expensewith reasonable accuracy.

Economic performance rule. Under anaccrual method, you generally cannot deductor capitalize business expenses until eco-nomic performance occurs. If your expenseis for property or services provided to you, orfor your use of property, economic perform-ance occurs as the property or services areprovided, or as the property is used. If yourexpense is for property or services you pro-vide to others, economic performance occursas you provide the property or services.

Example. Your tax year is the calendaryear. In December 1999, the Field PlumbingCompany did some repair work at your placeof business and sent you a bill for $150. Youpaid it by check in January 2000. If you usean accrual method of accounting, deduct the$150 on your tax return for 1999 because allevents that set the amount of liability andeconomic performance occurred in that year.If you use the cash method of accounting, youcan deduct the expenses on your 2000 return.

Prepayment. You cannot deduct expensesin advance, even if you pay them in advance.This rule applies to both the cash and accrualmethods. It applies to prepaid interest, pre-paid insurance premiums, and any other ex-

pense paid far enough in advance to, in ef-fect, create an asset with a useful lifeextending substantially beyond the end of thecurrent tax year.

Example. In 1999, you sign a 10-yearlease and immediately pay your rent for thefirst 3 years. Even though you paid the rentfor 1999, 2000, and 2001, you can deductonly the rent for 1999 on your current tax re-turn. You can deduct on your 2000 and 2001tax returns the rent for those years.

Contested liabilities. Under the cashmethod, you can deduct a contested liabilityonly in the year you pay the liability. Underan accrual method, you can deduct contestedliabilities, such as taxes (except foreign orU.S. possession income, war profits, and ex-cess profits taxes), in the tax year you pay theliability (or transfer money or other propertyto satisfy the obligation) or in the tax year yousettle the contest. However, to take the de-duction in the year of payment or transfer, youmust meet certain conditions. See ContestedLiability in Publication 538 for more informa-tion.

Related persons. Under an accrual methodof accounting, you generally deduct expenseswhen you incur them, even if you have notpaid them. However, if you and the personyou owe are related persons and the personyou owe uses the cash method of accounting,

you must pay the expense before you candeduct it. The deduction by an accrualmethod payer is allowed when the corre-sponding amount is includible in income bythe related cash method payee. See RelatedPersonsin Publication 538.

Not-for-ProfitActivitiesIf you do not carry on your business or in-vestment activity to make a profit, there is alimit on the deductions you can take. Youcannot use a loss from the activity to offsetother income. Activities you do as a hobby,or mainly for sport or recreation, come underthis limit. So does an investment activity in-tended only to produce tax losses for the in-vestors.

The limit on not-for-profit losses applies toindividuals, partnerships, estates, trusts, andS corporations. It does not apply to corpo-rations other than S corporations.

In determining whether you are carryingon an activity for profit, all the facts are takeninto account. No one factor alone is decisive.Among the factors to consider are whether:

1) You carry on the activity in a business-like manner,

2) The time and effort you put into the ac-tivity indicate you intend to make it prof-itable,

3) You depend on income from the activityfor your livelihood,

4) Your losses are due to circumstancesbeyond your control (or are normal in thestart-up phase of your type of business),

5) You change your methods of operationin an attempt to improve profitability,

6) You, or your advisors, have the knowl-edge needed to carry on the activity as

a successful business,7) You were successful in making a profit

in similar activities in the past,

8) The activity makes a profit in someyears, and how much profit it makes, and

9) You can expect to make a future profitfrom the appreciation of the assets usedin the activity.

Limit on Deductionsand LossesIf your activity is not carried on for profit, takedeductions only in the following order, only tothe extent stated in the three categories, and,if you are an individual, only if you itemizethem on Schedule A (Form 1040).

Category 1. Deductions you can take forpersonal as well as for business activities areallowed in full. For individuals, all nonbusi-ness deductions, such as those for homemortgage interest, taxes, and casualty losses,belong in this category. Deduct them on theappropriate lines of Schedule A (Form 1040).You can only deduct a casualty loss onproperty you own for personal use to the ex-tent it is more than $100 and all these lossesexceed 10% of your adjusted gross income.See Publication 547 for more information oncasualty losses. For the limits that apply tomortgage interest, see Publication 936.

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Category 2. Deductions that do not result inan adjustment to the basis of property areallowed next, but only to the extent your grossincome from the activity is more than the de-ductions you take (or could take) for it underthe first category. Most business deductions,such as those for advertising, insurance pre-miums, interest, utilities, wages, etc., belongin this category.

Category 3. Business deductions that de-crease the basis of property are allowed last,

but only to the extent the gross income fromthe activity is more than deductions you take(or could take) for it under the first two cate-gories. The deductions for depreciation,amortization, and the part of a casualty lossan individual could not deduct in category (1)belong in this category. Where more than oneasset is involved, divide depreciation andthese other deductions proportionally amongthose assets.

TIPIndividuals must claim the amounts incategories (2) and (3) as miscella-neous deductions on Schedule A

(Form 1040). They are subject to the2%-of-adjusted-gross-income limit. See Pub-lication 529 for information on this limit.

Example. Ida is engaged in a not-for-profit activity. The income and expenses ofthe activity are as follows:

Ida must limit her deductions to $3,200,the gross income she earned from the activ-ity. The limit is reached in category (3), as

follows:

The $300 for depreciation is divided be-tween the automobile and machine, as fol-lows:$600

$300 = $225 depreciation for the automobile$800

$200 $300 = $75 depreciation for the machine

$800

The basis of each asset is reduced ac-

cordingly.The $1,600 for category (1) is deductible

in full on the appropriate lines for taxes andinterest on Schedule A (Form 1040). Ida addsthe remaining $1,600 (the total of categories(2) and (3)) to her other miscellaneous de-ductions on Schedule A (Form 1040) that aresubject to the 2%-of-adjusted-gross-incomelimit.

Partnerships and S corporations. If apartnership or S corporation carries on anot-for-profit activity, these limits apply at thepartnership or S corporation level. They arereflected in the individual shareholder's orpartner's distributive shares.

More than one activity. If you have severalundertakings, each may be a separate activityor several undertakings may be one activity.The following are the most significant factsand circumstances in making this determi-nation.

The degree of organizational and eco-nomic interrelationship of various under-takings.

The business purpose that is (or mightbe) served by carrying on the various

undertakings separately or together in abusiness or investment setting.

The similarity of various undertakings.

The IRS will generally accept your char-acterization of several undertakings as oneactivity, or more than one activity, if supportedby facts and circumstances.

TIPIf you are carrying on two or moredifferent activities, keep the de-ductions and income from each one

separate. Figure separately whether each isa not-for-profit activity. Then figure the limiton deductions and losses separately for eachactivity that is not for profit.

Presumption of ProfitAn activity is presumed carried on for profit ifit produced a profit in at least 3 of the last 5tax years including the current year. Activitiesthat consist primarily of breeding, training,showing, or racing horses are presumed car-ried on for profit if they produced a profit inat least 2 of the last 7 tax years including thecurrent year. You have a profit when thegross income from an activity is more than thedeductions for it.

If a taxpayer dies before the end of the5-year (or 7-year) period, the period ends onthe date of the taxpayer's death.

If your business or investment activitypasses this 3- (or 2-) years-of-profit test, pre-sume it is carried on for profit. This means it

will not come under these limits. You can takeall your business deductions from the activity,even for the years that you have a loss. Youcan rely on this presumption in every case,unless the IRS shows it is not valid.

Using the presumption later. If you arestarting an activity and do not have 3 (or 2)years showing a profit, you may want to takeadvantage of this presumption later, after youhave the 5 (or 7) years of experience allowedby the test.

You can choose to do this by filing Form5213. Filing this form postpones any deter-mination that your activity is not carried on forprofit until 5 (or 7) years have passed sinceyou started the activity.

TIPForm 5213 must be filed within 3years of the due date of your returnfor the year in which you first carried

on the activity, or, if earlier, within 60 days ofreceiving written notice from the InternalRevenue Service proposing to disallow de-ductions attributable to the activity.

The benefit gained by making this choiceis that the IRS will not immediately questionwhether your activity is engaged in for profit.Accordingly, it will not restrict your de-ductions. Rather, you will gain time to earna profit in 3 (or 2) out of the first 5 (or 7) years

you carry on the activity. If you show 3 (or2) years of profit at the end of this period, yourdeductions are not limited under these rules.If you do not have 3 (or 2) years of profit, thelimit can be applied retroactively to any yearin the 5-year (or 7-year) period with a loss.

Filing Form 5213 automatically extendsthe period of limitations on any year in the5-year (or 7-year) period to 2 years after thedue date of the return for the last year of theperiod. The period is extended only for de-ductions of the activity and any related de-ductions that might be affected.

2.

Employees' Pay

IntroductionYou can generally deduct the pay you giveyour employees for the services they perform

for your business. The pay may be in cash,property, or services. It may include wages,salaries, vacation allowances, bonuses,commissions, and fringe benefits.

This chapter provides information aboutdeductions allowed for various kinds of pay.Chapters 3, 4, and 5 provide additional infor-mation about the treatment of certain benefitsyou furnish to employees.

For information about determining who isan employee and about employment taxeson your employees' pay, see Publication 15,Circular E, Employer's Tax Guide, and Publi-cation 15A, Employer's Supplemental TaxGuide. For information about deducting em-ployment taxes paid on your employees'wages, see chapter 9.

TIPYou can claim the following employ-ment credits if you hire individualswho meet certain requirements.

Empowerment zone employment credit.

Indian employment credit.

Welfare-to-work credit.

Work opportunity credit.

However, you must reduce your deduction foremployee wages by the amount of any em-ployment credits you claim. For more infor-mation about these credits, see Publication954, Tax Incentives for Empowerment Zonesand Other Distressed Communities.


Tests for deductibility

Kinds of payments



W2 Wage and Tax Statement

1099MISC Miscellaneous Income

Gross income ............................................... $3,200

Minus expenses:Real estate taxes ........................... $700Home mortgage interest ................ 900Insurance ........................................ 400Utilities ............................................ 700Maintenance ................................... 200Depreciation on an automobile ...... 600Depreciation on a machine ............ 200 3,700

Loss ............................................................. $ 500

Limit on deduction ....................................... $3,200

Category 1: Taxes and interest ...... $1,600Category 2: Insurance, utilities, andmaintenance .................................... 1,300 2,900

Available for Category 3 ........................... $ 300

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Tests for DeductibilityTo be deductible, your employees' pay mustbe an ordinary and necessary expense andyou must pay or incur it in the tax year. Theseand other requirements that apply to all busi-ness expenses are explained under What

Can Be Deducted? and When Can an Ex-pense Be Deducted?in chapter 1.In addition, the pay must meet both of the

following tests.

Test 1. The pay must be reasonable.

Test 2. The pay must be for servicesperformed.

If these tests are met, the form or method offiguring the pay does not affect its deductibil-ity. For example, bonuses and commissionsbased on sales or earnings and paid underan agreement made before the services wereperformed are generally deductible.

Employee-shareholder salaries. If a cor-poration pays an employee who is also ashareholder a salary that is unreasonablyhigh considering the services actually per-formed by the employee-shareholder, the ex-cessive part of the salary may be treated asa constructive distribution of earnings to theemployee-shareholder. For more informationon corporate distributions to shareholders,see Publication 542, Corporations.

Test 1ReasonableDetermine the reasonableness of pay by thefacts. Generally, reasonable pay is theamount that like enterprises ordinarily wouldpay for the services under similar circum-stances.

You must be able to prove the pay isreasonable. Base this test on the circum-stances that exist when you contract for theservices, not those existing when the rea-sonableness is questioned. If the pay is ex-cessive, you can deduct only the part that isreasonable.

Factors to consider. To determine if pay isreasonable, consider the following items andany other pertinent facts.

The duties performed by the employee.

The volume of business handled.

The character and amount of responsi-

bility. The complexities of your business.

The amount of time required.

The general cost of living in the locality.

The ability and achievements of the indi-vidual employee performing the service.

The pay compared with the amount ofgross and net income of the business,as well as with distributions to share-holders if the business is a corporation.

Your policy regarding pay for all of youremployees.

The history of pay for each employee.

Individual salaries. You must base the testof whether a salary is reasonable on eachindividual's salary and the service performed,not on the total salaries paid to all officers orall employees. For example, even if the totalamount you pay to your officers is reason-able, you cannot deduct an individual officer'sentire salary if it is not reasonable based onthe items listed above.

Test 2For Services

PerformedYou must be able to prove the payment wasmade for services actually performed.

Kinds of PaymentsSome of the ways you may provide pay toyour employees are discussed next.

AwardsYou can generally deduct amounts you payto your employees as awards, whether paidin cash or property. However, if you giveproperty to an employee as an employeeachievement award, your deduction may be

limited.

Employee achievement awards. Your de-duction for the cost of employee achievementawards given to any one employee during thetax year is subject to the following limits.

$400 for awards that are not qualifiedplan awards.

$1,600 for all awards, whether or notqualified plan awards.

Include the cost that is not more than theabove limits on the Other deductions line ofyour tax return or business schedule.

An employee achievement award is anitem of tangible personal property that

meets all the following requirements.

It is given for length of service or safetyachievement.

It is awarded as part of a meaningfulpresentation.

It is awarded under conditions and cir-cumstances that do not create a signif-icant likelihood of disguised pay.

Length-of-service award. An award willnot qualify as a length-of-service achievementaward if either of the following applies.

The employee receives the award duringhis or her first 5 years of employment.

The employee received a length-of-service award (other than one of verysmall value) during that year or in any ofthe prior 4 years.

Safety achievement award. An awardwill not qualify as a safety achievement awardif it is given to either of the following.

1) A manager, administrator, clerical em-ployee, or other professional employee.

2) More than 10% of the employees duringthe year, excluding those listed in (1).

Qualified plan award. This is an em-ployee achievement award that you awardedas part of an established written plan or pro-

gram that does not favor highly compensatedemployees as to eligibility or benefits. SeeExclusion of Certain Fringe Benefits in chap-ter 4 for the definition of a highly compen-sated employee.

An award is not a qualified plan award ifthe average cost of all the employeeachievement awards given during the tax year(that would be qualified plan awards exceptfor this limit) is more than $400. To figure thisaverage cost, do not take into account awardsof very small value.

Exclusion from employee's wages. Ifthe cost of employee achievement awardsyou give an employee is not more than thelimits, you can exclude the awards from theemployee's wages.

If the awards cost more than the amountyou can deduct, include in the employee'swages the largerof the following amounts.

The part of the cost of the awards youcannot deduct (up to the awards' fairmarket value).

The amount by which the fair marketvalue of the awards is more than theamount you can deduct.

Do not include the remaining value of theawards in the employee's wages.

BonusesYou can deduct a bonus paid to an employeeif you intended the bonus as additional payfor services, not as a gift, and the serviceswere actually performed. It does not matterwhether you pay the bonus in cash, property,or a combination of both. However, for you todeduct the amount as employee pay, the totalbonuses, salaries, and other pay must bereasonable for the services performed. In-clude the bonus in the employee's wages.

Gifts of nominal value. If, to promote em-ployee goodwill, you distribute turkeys, hams,

or other merchandise of nominal value to youremployees at holidays, the value of theseitems is not salary or wages. You can deductthe cost of these items as a business expenseeven though the employees do not includethe items in income.

If you distribute cash, gift certificates, orsimilar items readily convertible to cash, thevalue of these items is additional wages orsalaries, regardless of the amount or value.

Education ExpensesIf you pay or reimburse education expensesfor an employee enrolled in a course not re-quired for the job or not otherwise related tothe job, deduct the payment as wages. Youmust include the payment in the employee'swages, and it is subject to FICA and FUTAtaxes and income tax withholding. However,if the payment is part of a qualified educa-tional assistance program, these rules maynot apply. See chapter 5.

If you pay or reimburse education ex-penses for an employee enrolled in a job-related course, you can deduct the paymentas a noncompensatory business expense.Since this expense would be deductible ifpaid by the employee, it is called a workingcondition fringe benefit. Do not include aworking condition fringe benefit in an em-ployee's wages. Working condition fringebenefits are discussed in more detail inchapter 4.

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Employee Benefit ProgramsYou can generally deduct amounts you spendon employee benefit programs as a businessexpense. Employee benefit programs includethe following.

Accident and health plans (includingmedical savings accounts).

Adoption assistance.

Cafeteria plans.

Dependent care assistance.

Educational assistance.

Group-term life insurance coverage.

Welfare benefit funds.

Claim your deduction for these programson the employee benefit programs line ofyour tax return or business schedule. How-ever, if you provide dependent care by oper-ating a dependent care facility for your em-ployees, deduct your costs in whatevercategories they fall (depreciation, utilities,salaries, etc.).

For more information about employeebenefit programs, see chapter 5. Also, seeFringe Benefitsand Meals and Lodging, laterin this chapter.

Group-term life insurance. You cannot de-duct the cost of group-term life insurance ifyou are directly or indirectly the beneficiaryof the policy.

Limit on deduction for welfare benefitfunds. Your deduction for the cost of em-ployee benefit programs provided under awelfare benefit fund is limited to the fund'squalified cost for the tax year. However, ifyour contributions to the fund are more thanits qualified cost, you can carry the excessover to the next tax year.

A welfare benefit fund is a funded plan (ora funded arrangement having the effect of aplan) that provides welfare benefits to your

employees, independent contractors, or theirbeneficiaries. Welfare benefits are any ben-efits other than deferred compensation ortransfers of restricted property.

Qualified cost. Generally, this is the totalof the following amounts, reduced by theafter-tax income of the fund.

The cost you would have been able todeduct using the cash method of ac-counting if you had paid for the benefitsdirectly.

The contributions added to a reserve ac-count that are needed to fund claims in-curred but not paid as of the end of theyear for supplemental unemploymentbenefits, severance pay, or disability,

medical, or life insurance benefits.

For more information, see sections 419(c)and 419A of the Internal Revenue Code andthe related regulations.

Fringe BenefitsA fringe benefit is a form of pay provided toany person for the performance of servicesby that person. You can deduct the cost offringe benefits you provide. The following areexamples of fringe benefits.

The use of a car.

Flights on airplanes.

Discounts on property or services.

Memberships in country clubs or othersocial clubs.

Tickets to entertainment or sportingevents.

Include your deduction for fringe benefitson your tax return or business schedule inwhatever category the cost falls. For exam-ple, if you allow an employee to use a car orother property you lease, deduct the cost ofthe lease as a rent or lease expense. If you

own the property, include your deduction forits cost or other basis as a section 179 de-duction or a depreciation deduction.

For more information about fringe bene-fits, see chapter 4. Also, see Employee Ben-efit Programs, earlier, and Meals and Lodg-ing, later, in this chapter.

Loans or AdvancesYou generally can deduct as employee paya loan or advance you make to an employeethat you do not expect the employee to repayif it is for personal services actually per-formed. The total must be reasonable whenyou add the loan or advance to the employ-ee's other pay, and it must meet the tests for

deductibility, discussed earlier. However, ifthe employee performs no services, treat theamount you advanced to the employee as aloan, which you cannot deduct.

Below-market interest rate loans. On cer-tain loans you make to an employee orshareholder, you are treated as having re-ceived interest income and as having paidcompensation or dividends equal to that in-terest. See Below-Market Loans in chapter8 for more information.

Meals and LodgingYou can usually deduct the cost of furnishingmeals and lodging to your employees. How-

ever, you can generally deduct only 50% ofyour costs of furnishing meals.Deduct the cost on your tax return or

business schedule in whatever category theexpense falls. For example, if you operate arestaurant, deduct the cost of the meals youfurnish to your employees as part of the costof goods sold. If you operate a nursing home,motel, or rental property, deduct the costs offurnishing lodging to an employee as ex-penses for utilities, linen service, salaries,depreciation, etc.

For more information about meals andlodging furnished to employees, see chapter3.

Deduction limit on meals. You can gener-ally deduct only 50% of the costs of furnishing

meals to your employees. However, you candeduct the full costs of the following meals.

Meals that qualify as a de minimis fringebenefit, as discussed in chapter 4.

Meals whose value you must include inan employee's wages. For more infor-mation, see chapter 3.

Meals you furnish to your employees atthe work site when you operate a res-taurant or catering service.

Meals you furnish to your employees aspart of the expense of providing recre-ational or social activities, such as acompany picnic.

Meals you must furnish to crew membersof a commercial vessel under a federallaw. This includes crew members ofcommercial vessels operating on theGreat Lakes, the Saint LawrenceSeaway, or any U.S. inland waterway ifmeals would be required under federallaw had the vessel been operated at sea.This does not include meals you furnishon vessels primarily providing luxury wa-ter transportation.

Meals you furnish on an oil or gas plat-

form or drilling rig located offshore or inAlaska. This includes meals you furnishat a support camp that is near and inte-gral to an oil or gas drilling rig located inAlaska.

PropertyIf you transfer property (including your com-pany's stock) to an employee as payment forservices, you can deduct it as wages. Theamount you can deduct, and the amount youmust include in the employee's wages, is itsfair market value on the date of the transferminus any amount the employee paid for theproperty. You treat the deductible amount asreceived in exchange for the property, and

you must recognize any gain or loss realizedon the transfer. Your gain or loss is the dif-ference between the fair market value of theproperty and its adjusted basis on the dateof transfer.

CAUTION

!A corporation recognizes no gain orloss when it pays for services with itsown stock.

You can claim the deduction only for yourtax year in which the employee includes theproperty's value in income. The employee isdeemed to have included the value in incomeif you report it on Form W2 in a timelymanner.

These rules also apply to property trans-

ferred to an independent contractor, generallyreported on Form 1099MISC.

Restricted property. If the property youtransfer for services is subject to restrictionsthat affect its value, you generally cannot de-duct it and do not report gain or loss until itis substantially vested in the recipient. How-ever, if the recipient pays for the property, youmust report any gain at the time of the trans-fer up to the amount paid.

Substantially vested means the propertyis not subject to a substantial risk of forfeiture.The recipient is not likely to have to give uphis or her rights in the property in the future.

Reimbursementsfor Business ExpensesYou can generally deduct the amount you payor reimburse employees for business ex-penses they incur for you for items such astravel and entertainment. However, your de-duction for meal and entertainment expensesis usually limited to 50% of the payment.

If you make the payment under an ac-countable plan, deduct it in the category ofthe expense paid. For example, if you pay anemployee for travel expenses incurred onyour behalf, deduct this payment as a travelexpense on your tax return or businessschedule. See the instructions for the formyou file for information on which lines to use.

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If you make the payment under a nonac-countable plan, include it in your employee'swages and deduct it as wages on your taxreturn or business schedule.

See Travel, Meals, and Entertainment inchapter 16 for more information about de-ducting reimbursements and an explanationof accountable and nonaccountable plans.

Sick PayYou can deduct amounts you pay to youremployees for sickness and injury, includinglump-sum amounts, as compensation. How-ever, your deduction is limited to amounts notcompensated by insurance or other means.

Vacation PayVacation pay is an amount you pay or will payto an employee while the employee is on va-cation. It includes an amount you pay anemployee even if the employee chooses notto take a vacation. Vacation pay does not in-clude any sick pay or holiday pay.

You can ordinarily deduct vacation payonly in your tax year in which the employeeactually receives it. This rule applies regard-less of whether you use the cash method oran accrual method of accounting.

However, you can deduct vacation pay inyour tax year in which the employee earns itif it is vested by the end of that year and theemployee actually receives it within 21/2months after the end of that year. Generally,vacation pay is vested if it is payable underan oral or written vacation pay plan that youtold your employees about before the tax yearand its amount and your liability for it arecertain.

3.

Meals andLodgingFurnished toEmployees

Important ReminderMeals furnished on your business prem-ises. If you furnish meals to employees on

your business premises and more than halfof these employees are furnished the mealsfor your convenience, then all the meals areconsidered furnished for your convenience.See Test 2For Your Convenience underExclusion From Employee Wages. Thismeans that you can exclude the value of allthe meals from the employees' wages.

IntroductionIf you furnish meals or lodging to an em-ployee, or to anyone else in connection withthe employee's services, you must generallyinclude the value in the employee's wages.

You determine the value using the rules ex-plained in chapter 4.

This chapter explains a special rule thatallows you to exclude the value of meals andlodging from an employee's wages if youmeet certain tests. See chapter 4 for infor-mation on excluding the value of certainmeals as a de minimis fringe benefit.

For information about deducting the costof meals and lodging furnished to an em-ployee, see chapter 2.

Exclusion FromEmployee WagesYou can exclude from an employee's wagesthe value of meals and lodging you, or a thirdparty on your behalf, furnish to the employeeor the employee's spouse or dependents ifyou meet all the following tests.

Test 1. You furnish the meals or lodgingon your business premises.

Test 2. You furnish the meals or lodgingfor your convenience.

Test 3. In the case of lodging (but not

meals), you require your employee toaccept the lodging on your businesspremises as a condition of his or heremployment.

However, if an employee can choose toreceive additional pay instead of meals orlodging, you must include the value of themeals or lodging in the employee's wages.The examples at the end of this chapter willhelp you apply these tests.

TIPThe value of meals and lodging youproperly exclude from an employee'swages is not subject to social security,

Medicare, and federal unemployment taxes,or income tax withholding.

Test 1On YourBusiness PremisesThis generally means the place of employ-ment. For example, meals and lodging youfurnish to a household employee in your pri-vate home are furnished on your businesspremises. Similarly, meals you furnish tocowhands while herding cattle on land youlease or own are furnished on your businesspremises.

Test 2For YourConvenienceWhether you furnish meals or lodging for yourconvenience as an employer depends on allthe facts and circumstances. You furnish themeals or lodging to your employee for yourconvenience if you do this for a substantialbusiness reason other than to provide theemployee with additional pay. This is trueeven if a law or an employment contract pro-vides that they are furnished as pay. A writtenstatement that the meals or lodging are foryour convenience is not sufficient.

Substantial nonpay reasons. The followingmeals are furnished for a substantial nonpaybusiness reason.

Meals you furnish during working hoursso your employee will be available for

emergency calls during the meal period.However, you must be able to show thatthese emergency calls have occurred orcan reasonably be expected to occur.

Meals you furnish during working hoursbecause the nature of your business re-stricts your employee to a short mealperiod (such as 30 or 45 minutes), andthe employee cannot be expected to eatelsewhere in such a short time. For ex-ample, meals can qualify if the peakworkload occurs during the normal lunch

hour. But if the reason for the short mealperiod is to allow the employee to leaveearlier in the day, the meal will not qualify.

Meals you furnish during work hours be-cause your employee could not otherwiseeat proper meals within a reasonableperiod of time. For example, meals canqualify if there are insufficient eating fa-cilities near the place of employment.

Meals you furnish to a restaurant or otherfood service employee for each mealperiod in which the employee works, ifyou furnish the meals during, immediatelybefore, or immediately after work hours.For example, if a waitress works throughthe breakfast and lunch periods, you canexclude from her wages the value of thebreakfast and lunch you furnish in yourrestaurant for each day she works.

Meals you furnish immediately afterworking hours that you would have fur-nished during working hours for a sub-stantial nonpay business reason but that,because of the work duties, were noteaten during working hours.

All meals you furnish to employees onyour business premises if more than halfof these employees are furnished mealsfor a substantial nonpay business reason.

Meals you furnish to promote goodwill,boost morale, or attract prospective em-ployees. These meals are considered fur-nished in your business for pay reasons. Theyare not furnished for your convenience unlessyou also have a substantial nonpay businessreason for furnishing the meals.

Meals furnished on nonworkdays or withlodging. The value of meals you furnish onany nonworkday is normally not furnished foryour convenience. However, if your employ-ees must occupy lodging on your businesspremises as a condition of employment, asdiscussed later under Test 3Lodging Re-quired as a Condition of Employment, do nottreat the value of any meal you furnish on thebusiness premises as wages.

Meals with a charge. The fact that youcharge for the meals and that your employeesmay accept or decline the meals is not takeninto account in determining whether mealsare furnished for your convenience.

If you furnish meals for which you chargethe employees a flat amount whether or notthey eat the meals, do not include the flatamount you charge in your employees'wages. Whether the value of the meals iswages depends on whether you meet Tests1 and 2. If you do not meet both of thesetests, you must include the value of the mealsin your employees' wages whether it is moreor less than the amount you charged. If noevidence indicates otherwise, the value of themeals is the amount you charged for them.

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Test 3Lodging Requiredas a Condition ofEmploymentThis means that you require your employeesto accept the lodging because they need tolive on your business premises to be able toproperly perform their duties. Examples in-clude employees who must be available atall times and employees who could not per-form their required duties without being fur-nished the lodging.

It does not matter whether you must fur-nish the lodging as pay under the terms ofan employment contract or a law fixing theterms of employment.

You may furnish the lodging to your em-ployees with or without a charge. If youcharge a flat amount for lodging whether ornot the employee accepts it, do not includethe flat charge in the employee's wages.Whether the value of the lodging is wagesdepends on whether you meet Tests 1, 2, and3. If you do not meet all of these tests, youmust include the value of the lodging in youremployees' wages whether it is more or lessthan the amount you charged for it. If no evi-dence indicates otherwise, the value of thelodging is the amount you charged for it.

ExamplesThese examples will help you determinewhether to include in your employees' wagesthe value of meals or lodging you furnish tothem.

Example 1 (Meals). You operate a restau-rant business. You furnish your employee,Carol, who is a waitress working 7 a.m. to 4p.m., two meals during each workday. Youencourage but do not require Carol to haveher breakfast on the business premises be-fore starting work. She must have her lunchon the premises. Since Carol is a food serviceemployee and works during the normal

breakfast and lunch periods, do not includethe value of her breakfast and lunch in herwages.

Example 2 (Meals on nonworkdays). Thefacts are the same as in Example 1, exceptthat you also allow Carol to have meals onyour business premises without charge on herdays off. You must include the value of thesemeals in her wages.

Example 3 (Meals). Frank is a bank tellerwho works from 9 a.m. to 5 p.m. The bankfurnishes his lunch without charge in a cafe-teria the bank maintains on its premises. Thebank furnishes these meals to Frank to limithis lunch period to 30 minutes, since thebank's peak workload occurs during thenormal lunch period. If Frank got his lunchelsewhere, it would take him much longerthan 30 minutes, and the bank strictly en-forces the time limit. The bank does not in-clude the value of these meals in Frank'swages.

Example 4 (Meals). A hospital maintains acafeteria on its premises where all of its 230employees may get meals at no charge dur-ing their working hours. The hospital furnishesmeals to have 120 employees available foremergencies. Each of these employees is attimes called upon to perform services duringthe meal period. Although the hospital doesnot require these employees to remain on the

premises, they rarely leave the hospital duringtheir meal period. Since the hospital furnishesmeals to its employees to have more than halfof them available for emergency calls duringmeal periods, the hospital does not includethe value of these meals in the wages of anyof its employees.

Example 5 (Lodging). A hospital gives Joan,an employee of the hospital, the choice ofliving at the hospital free of charge or livingelsewhere and receiving a cash allowance inaddition to her regular salary. If Joan choosesto live at the hospital, the hospital must in-clude the value of the lodging in her wagesbecause she is not required to live at thehospital to properly perform the duties of heremployment.

4.

Fringe Benefits

Important Changefor 1999Vehicle cents-per-mile rule. The standardmileage rate you can use under the vehiclecents-per-mile rule to value the personal useof a car, van, pickup, or panel truck you pro-vide to an employee in 1999 is 321/2 cents amile for all personal miles driven before April1. The rate is 31 cents a mile for personalmiles driven after March 31. See VehicleCents-Per-Mile Rule.

Important RemindersMeals furnished to employees. If the valueof meals you provide at your eating facility foremployees can be excluded from their wagesbecause you furnish them for your conven-ience, your revenue from the meals is con-sidered to equal the facility's direct operatingcosts for them. This means that you may beable to treat the meals as a de minimis fringebenefit and deduct all of their cost. See DeMinimis (Minimal) Fringe.

Qualified transportation fringe benefits inplace of pay. You can exclude qualifiedtransportation fringe benefits from an em-

ployee's wages even if you provide them inplace of pay. See Qualified TransportationFringe.

IntroductionIf you provide a fringe benefit to an employee,you must generally include the value in theemployee's wages. This chapter explains thevaluation rules for fringe benefits that you in-clude in an employee's wages. However, itdoes not cover all the exceptions to theserules, or the rules that apply to the use of anaircraft. For more information, see section1.6121 of the regulations.

This chapter also discusses some specialrules that allow you to exclude the value ofcertain fringe benefits from an employee'swages. See chapters 3 and 5 for informationon excluding the value of certain other bene-fits from wages.

For information about deducting the costof fringe benefits, see chapter 2.


General information The general valuation rule

Special valuation rules

Exclusion of certain fringe benefits fromemployee income


Publication

15 Circular E, Employer's Tax Guide

15A Employer's Supplemental TaxGuide


W2 Wage and Tax Statement

1099MISC Miscellaneous Income


General InformationA fringe benefit is a form of pay provided toany person for the performance of servicesby that person. For the rules discussed in thischapter, treat a person who agrees not toperform services (such as under a covenantnot to compete) as performing services.

Examples of fringe benefits you may pro-vide include the following items.

The use of a car.

Flights on airplanes.

Discounts on property or services.

Memberships in country clubs or othersocial clubs.

Tickets to entertainment or sportingevents.

Provider of fringe benefit. You are theprovider of a fringe benefit if it is provided forservices performed for you. You may be theprovider of the benefit even if it was providedby another person. For example, you are theprovider of a fringe benefit your client or cus-tomer provides to your employee for servicesthe employee performs for you.

Nonemployer provider. You do not haveto be the employer of the recipient to be theprovider of a fringe benefit. For example, youmay provide fringe benefits to an independentcontractor as a client or customer of the con-tractor.

Recipient of benefit. Your employee orsome other person who performs services foryou is the recipient of a fringe benefit providedfor those services. Your employee may be therecipient of the benefit even if it is providedto someone who did not perform services for

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you. For example, your employee may be therecipient of a fringe benefit you provide to amember of the employee's family.

The recipient does not have to be youremployee. For example, the recipient may bea partner, director, or independent contractor.In this chapter, the term employee includesany recipient of a fringe benefit unless statedotherwise.

Including benefits in pay. Unless the lawsays otherwise, you must include the valueof fringe benefits in the recipient's pay.

If the recipient of a taxable fringe benefitis your employee, the benefit is subject toemployment taxes and must be reported onForm W2. However, you can use specialrules to withhold, deposit, and report the em-ployment taxes. See Publication 15 andPublication 15A for more information.

If the recipient of a taxable fringe benefitis not your employee, the benefit is not sub-

ject to employment taxes. However, you mayhave to report it on Form 1099MISC and youmay have to withhold income tax under thebackup withholding rules. See the Instructionsfor Forms 1099, 1098, 5498, and W2G formore information.

GeneralValuation RuleYou generally must include in an employee'swages the amount by which the fair marketvalueof a fringe benefit is more than the sumof the following amounts.

1) Any amount the employee paid for thebenefit.

2) Any amount the law excludes from in-come.

However, you and the employee may usespecial rules to value certain fringe benefits.

(See Special Valuation Rules, later.)If the law excludes a fringe benefit costfrom gross income, do not include in the em-ployee's wages the difference between thefair market value and the excludable cost ofthat fringe benefit. If the law excludes a lim-ited amount of the cost, however, include thefair market value of the fringe benefit that isdue to any excess cost.

Fair market value (FMV). In general, youdetermine the FMV of a fringe benefit on thebasis of all the facts and circumstances. TheFMV of a fringe benefit is the amount theemployee would have to pay a third party inan arm's-length transaction to buy or leasethe particular fringe benefit.

Neither the amount the employee consid-ers to be the value of the fringe benefit nor thecost you incur to provide the benefit deter-mines its FMV.

Employer-provided vehicles. In general,the value of an employer-provided vehicle isthe amount the employee would have to paya third party to lease the same or a similarvehicle on the same or comparable terms inthe same geographic area where the em-ployee uses the vehicle. A comparable leaseterm would be the amount of time the vehicleis available for the employee's use, such asa 1-year period.

Do not determine the value by multiplyinga cents-per-mile rate times the number of

miles driven unless the employee can provethe vehicle could have been leased on acents-per-mile basis. (However, see VehicleCents-Per-Mile Rule, later.)

SpecialValuation RulesYou may be able to use special valuationrules instead of the general valuation rule to

value certain fringe benefits, including the useof any vehicle or eating facility you provide.The special valuation rules include the fol-lowing rules.

Automobile lease rule.

Commuting rule.

Employer-operated eating facility rule.

Unsafe conditions commuting rule.

Vehicle cents-per-mile rule.

Conditions for use. When reporting fringebenefits, you can choose to use any of thespecial rules. However, neither you nor theemployee may use a special rule to value any

benefit unless one of the following conditionsis met.

1) You treat the value of the benefit aswages for reporting purposes by the duedate of the return (including extensions)for the tax year you provide the benefit.

2) The employee includes the value of thebenefit in income by the due date of thereturn for the year the employee receivesthe benefit.

3) The employee is not a control employeeas defined later under Commuting Rule.

4) You demonstrate a good faith effort totreat the benefit correctly for reportingpurposes.

Using the special rules. All of the followingrules apply when you use the special rules.

1) If you use one of the special rules tovalue a benefit you provide to the em-ployee, the employee can use that spe-cial rule. If you do not use one of thespecial rules, the employee can use aspecial rule only if you do not treat thevalue of the benefit as wages for report-ing purposes by the due date of the re-turn (including extensions) and one ofthe conditions listed in items (2) through(4) above is met. In any case, the em-ployee can always use the general val-uation rule discussed earlier.

2) If you and the employee properly use aspecial rule, the employee must includein gross income the value you determineunder the rule minus any amount he orshe paid you and any amount excludedby law from gross income. If you alsoproperly determine the amount of theemployee's working condition fringebenefit (explained later under Exclusionof Certain Fringe Benefits), the em-ployee must include in gross income thenet value you determined minus anyamount he or she paid you. You and theemployee can use the special rule todetermine the amount the employeeowes you.

3) If you provide vehicles to more than oneemployee, you do not have to use thesame special rule for each employee. Ifyou provide a vehicle for use by morethan one employee (for example, anemployer-sponsored van pool), you canuse any special rule. However, you mustuse that rule for all employees who shareuse of the vehicle.

4) You can use the formulas in the specialrules only with those rules. When youproperly apply a special rule to a fringe

benefit, the IRS will accept your value forthat fringe benefit. However, if you donot properly apply a special rule, or if youuse a special rule but are not entitled todo so, the IRS will use the general valu-ation rule to value the fringe benefit.

More information. For more information onthe special valuation rules, including those notdiscussed in this chapter (such as the rulesfor aircraft), see section 1.6121(c)-(k) of theregulations.

Automobile Lease RuleIf you provide an employee with an automo-bile for an entire calendar year, you can usethe automobile's annual lease value to valuethe benefit. If you provide an employee withan automobile for less than an entire calendaryear, the value of the benefit is either a pro-rated annual lease value or the daily leasevalue. Include the lease value in the employ-ee's wages unless it is excluded from grossincome by law.

For this rule, automobile means anyfour-wheeled vehicle manufactured primarilyfor use on public streets, roads, and high-ways.

Benefits excluded for business use. If theemployee uses the automobile for business,he or she may qualify to exclude part of thelease value as a working condition fringebenefit. You can reduce the amount of the

lease value by the working condition fringeand include the net amount in the employee'swages, or you can choose to include the en-tire lease value. See Vehicle-allocation rulesunder Working Condition Fringe, later.

Annual Lease ValueGenerally, you figure the annual lease valueof an automobile as follows.

1) Determine the FMV of the automobileon the first date the automobile is avail-able to any employee for personal use.

2) Using the following Annual Lease ValueTable, read down column (1) until youcome to the dollar range within which the

FMV of the automobile falls. Then readacross to column (2) to find the annuallease value.

Annual Lease Value Table

(1) (2)Annual

Automobile LeaseFair Market Value Value

$0 to 999 .................................................. $ 6001,000 to 1,999 .......................................... 8502,000 to 2,999 .......................................... 1,1003,000 to 3,999 .......................................... 1,3504,000 to 4,999 .......................................... 1,6005,000 to 5,999 .......................................... 1,8506,000 to 6,999 .......................................... 2,1007,000 to 7,999 .......................................... 2,3508,000 to 8,999 .......................................... 2,600

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For vehicles with an FMV of more than$59,999, the annual lease value equals (.25 the FMV of the automobile) + $500.

Fair market value. The FMV of the auto-mobile is the amount a person would pay tobuy it from a third party, in an arm's-lengthtransaction, in the area in which the vehicleis bought or leased. That amount includes allpurchase expenses, such as sales tax andtitle fees.

If you have 20 or more automobiles, seesection 1.6121(d)(5)(v) of the regulations.See section 1.6121(d)(2)(ii) of the regu-lations if you and the employee own or leasethe automobile together.

You do not have to include the FMV of a

telephone or any specialized equipmentadded to, or carried in, the automobile if theequipment is necessary for your business.However, include the value of specializedequipment in the FMV if the employee towhom the automobile is available uses thespecialized equipment in a trade or businessother than yours.

Neither the amount the employee consid-ers to be the value of the fringe benefit noryour cost for either buying or leasing the au-tomobile determines its FMV. However, seeSafe-harbor value, next.

Safe-harbor value. You may be able touse a safe-harbor value as the FMV. For anautomobile you bought at arm's length, thesafe-harbor value is your cost, including tax,

title, and other purchase expenses. You can-not have been the manufacturer of the vehi-cle.

For an automobile you lease, you can useany of the following as the safe-harbor value.

1) The manufacturer's invoice price (in-cluding options) plus 4%.

2) The manufacturer's suggested retailprice minus 8% (including sales tax, title,and other expenses of purchase).

3) The retail value of the automobile re-ported by a nationally recognized pricingsource if that retail value is reasonablefor that automobile.

9,000 to 9,999 .......................................... 2,850 Items included in annual lease value table.Each annual lease value in the table includesthe FMV of maintenance and insurance forthe automobile. Do not reduce this value bythe FMV of any of these services that you didnot provide. For example, do not reduce theannual lease value by the FMV of a mainte-nance service contract or insurance you didnot provide. (You can take into account theservices actually provided for the automobileby using the general valuation rule discussedearlier.)

Items not included. The annual leasevalue does not include the FMV of fuel youprovide to an employee for personal use, re-gardless of whether you provide it, reimburseits cost, or have it charged to you. You mustinclude the value of the fuel separately in theemployee's wages. You can value fuel youprovided at FMV or at 5.5 cents per mile forall miles driven by the employee. However,you cannot value at 5.5 cents per mile fuelyou provide for miles driven outside theUnited States (including its possessions andterritories), Canada, and Mexico.

If you reimburse an employee for the costof fuel, or have it charged to you, you gener-ally value the fuel at the amount you reim-burse, or the amount charged to you if it wasbought at arm's length.

If you have 20 or more automobiles, seesection 1.6121(d)(3)(ii)(D) of the regulations.

If you provide any service other thanmaintenance and insurance for an automo-bile, you must add the FMV of that service tothe annual lease value of the automobile indetermining the value of the benefit.

Consistency rules. If you adopt the auto-mobile lease rule for an automobile, the fol-lowing rules apply.

1) You must adopt it by the first day youmake the automobile available to anyemployee for personal use. However,the following exceptions apply.

a) If you adopt the commuting rulewhen you first make the automobileavailable to any employee for per-sonal use, you can change to theautomobile lease rule on the firstday for which you do not use thecommuting rule.

b) If you adopt the vehicle cents-per-mile rule when you first make theautomobile available to any em-ployee for personal use, you canchange to the automobile lease ruleon the first day on which the auto-mobile no longer qualifies for thatrule.

2) You must use the rule for all later yearsin which you make the automobile avail-

able to any employee, except that youcan use the commuting rule for any yearduring which use of the automobilequalifies.

3) You must continue to use the rule if youprovide a replacement automobile to theemployee and your primary reason forthe replacement is to reduce federaltaxes.

4) The employee can use the automobilelease rule only if the employee uses therule beginning with the first day on whichthe automobile is made available to theemployee for personal use (and the em-ployer does not use the commuting rule).

4-year lease term. The annual lease valuesin the table are based on a 4-year lease term.These values will generally stay the same forthe period that begins with the first date youuse this special rule for the automobile andends on December 31 of the fourth full cal-endar year following that date.

Figure the annual lease value for eachlater 4-year period by determining the FMVof the automobile on January 1 of the firstyear of the later 4-year period and selectingthe amount in column 2 of the table that cor-responds to the appropriate dollar range incolumn 1.

Using the special accounting rule. Ifyou use the special accounting rule for fringebenefits discussed in Publication 15A, youcan figure the annual lease value for eachlater 4-year period at the beginning of thespecial accounting period that starts imme-diately before the January 1 date describedin the previous paragraph.

For example, assume that you use thespecial accounting rule and that, beginningon November 1, 1998, the special accountingperiod is November 1 to October 31. Youelected to use the automobile lease valuationrule as of January 1, 1999. You can refigurethe annual lease value on November 1, 2002,rather than on January 1, 2003.

Transferring an automobile from one em-ployee to another. Unless the primary pur-pose of the transfer is to reduce federal taxes,you can refigure the annual lease valuebased on the FMV of the automobile on Jan-uary 1 of the calendar year of transfer.

However, if you use the special account-ing rule for fringe benefits discussed in Pub-lication 15A, you can refigure the annuallease value (based on the FMV of the auto-mobile) at the beginning of the special ac-counting period in which the transfer occurs.If you do not refigure the annual lease value,the employee cannot refigure it.

Prorated annual lease value. If you provide

an automobile to an employee for continuousperiods of 30 or more days but less than anentire calendar year, you can prorate the an-nual lease value. Figure the prorated annuallease value by multiplying the annual leasevalue by a fraction, using the number of daysof availability as the numerator and 365 as thedenominator.

If you provide an automobile continuouslyfor at least 30 days, but the period covers 2calendar years (2 special accounting periodsif you are using the special accounting rule forfringe benefits discussed in Publication15A), you can use the prorated annual leasevalue or the daily lease value.

If you have 20 or more automobiles, seesection 1.6121(d)(6) of the regulations.

If an automobile is unavailable to the em-ployee because of his or her personal rea-sons (for example, if the employee is on va-cation), you cannot take into account theperiods of unavailability when you use a pro-rated annual lease value.

CAUTION

!You cannot use a prorated annuallease value if the reduction of federaltax is the main reason the automobile

is unavailable.

Daily lease value. If you provide an auto-mobile for continuous periods of one or morebut less than 30 days, use the daily leasevalue to figure its value. Figure the daily leasevalue by multiplying the annual lease value

10,000 to 10,999 ...................................... 3,10011,000 to 11,999 ...................................... 3,35012,000 to 12,999 ...................................... 3,60013,000 to 13,999 ...................................... 3,85014,000 to 14,999 ...................................... 4,10015,000 to 15,999 ...................................... 4,35016,000 to 16,999 ...................................... 4,60017,000 to 17,999 ...................................... 4,85018,000 to 18,999 ...................................... 5,10019,000 to 19,999 ...................................... 5,35020,000 to 20,999 ...................................... 5,60021,000 to 21,999 ...................................... 5,85022,000 to 22,999 ...................................... 6,10023,000 to 23,999 ...................................... 6,35024,000 to 24,999 ...................................... 6,60025,000 to 25,999 ...................................... 6,85026,000 to 27,999 ...................................... 7,25028,000 to 29,999 ...................................... 7,75030,000 to 31,999 ...................................... 8,25032,000 to 33,999 ...................................... 8,75034,000 to 35,999 ...................................... 9,25036,000 to 37,999 ...................................... 9,75038,000 to 39,999 ...................................... 10,25040,000 to 41,999 ...................................... 10,75042,000 to 43,999 ...................................... 11,25044,000 to 45,999 ...................................... 11,75046,000 to 47,999 ...................................... 12,25048,000 to 49,999 ...................................... 12,75050,000 to 51,999 ...................................... 13,25052,000 to 53,999 ...................................... 13,75054,000 to 55,999 ...................................... 14,25056,000 to 57,999 ...................................... 14,75058,000 to 59,999 ...................................... 15,250

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by a fraction, using four times the number ofdays of availability as the numerator and 365as the denominator.

However, you can apply a prorated annuallease value for a period of continuous avail-ability of less than 30 days by treating theautomobile as if it had been available for 30days. Use a prorated annual lease value if itwould result in a lower valuation than applyingthe daily lease value to the shorter period ofavailability.

Commuting RuleUnder this rule, the value of the commutinguse of a vehicle you provide is $1.50 perone-way commute (that is, from home to workor from work to home) for each employee whocommutes in the vehicle.

The term vehicle means any motorizedwheeled vehicle, including an automobile,manufactured primarily for use on publicstreets, roads, and highways.

You can use this special rule to figurecommuting value if all the following require-ments are met.

1) You own or lease the vehicle and pro-vide it to one or more employees for usein your trade or business.

2) For bona fide noncompensatory busi-ness reasons, you require the employeeto commute in the vehicle.

3) You establish a written policy underwhich you do not allow the employee touse the vehicle for personal purposes,other than for commuting or de minimispersonal use (such as a stop for a per-sonal errand on the way between abusiness delivery and the employee'shome).

4) The employee does not use the vehiclefor personal purposes, other than com-muting and de minimis personal use.

5) If this vehicle is an automobile, the em-

ployee who must use it for commuting isnot a control employee(defined later).

Personal use of a vehicle is all use that is notfor your trade or business.

An employer-provided vehicle generallyused each workday to carry at least threeemployees to and from work in an employer-sponsored commuting pool meets require-ments (1) and (2) above.

CAUTION

!Chauffeur-driven vehicle. If the ve-hicle is a chauffeur-driven vehicle, youcannot use the commuting valuation

rule for any passenger. However, you canuse it to value the commuting use of thechauffeur.

Control employees. A control employee ofa nongovernment employerfor 1999 is anyemployee who:

1) Was a board- or shareholder-appointed,confirmed, or elected officer of the em-ployer whose pay for the year was$70,000 or more,

2) Was a director of the employer,

3) Received pay for the year of $145,000or more from the employer, or

4) Owned a 1% or more equity, capital, orprofits interest in the employer.

Any individual who owns (or is consideredto own under section 318(a) of the InternalRevenue Code or principles similar to section318(a) for entities other than corporations) 1%or more of the FMV of an entity (the ownedentity) is considered a 1% owner of all otherentities grouped with the owned entity underthe rules of section 414(b), (c), (m), or (o).An employee who is an officer or director ofan employer is considered an officer or di-rector of all entities treated as a single em-ployer under section 414(b), (c), (m), or (o).

A control employee of a governmentemployerfor 1999 is any:

1) Elected official, or

2) Employee whose pay was at least$110,700 for the year (the pay of a fed-eral government employee at ExecutiveLevel V).

For the commuting rule, the term gov-ernment includes any federal, state, or localgovernmental unit and any of its agencies orinstrumentalities.

Instead of using the above definitions, youcan choose to treat all of your highly com-pensated employees as control employees.For the definition of a highly compensatedemployee, see Exclusion of Certain FringeBenefits, later.

Employer-OperatedEating Facility RuleYou can use this rule to determine the valueof taxable meals you provide at anemployer-operated eating facility for employ-ees. For situations in which you do not haveto include the value of meals in an employee'swages, see chapter 3 and the discussion un-der De Minimis (Minimal) Fringe, later.

Under this rule, you first figure the totalmeal valueof meals provided at the facility.Then you use that value to figure the valuefor each employee under either of the follow-

ing two methods.1) The individual meal subsidymethod.

2) The allocated total meal subsidymethod.

Employer-operated eating facility. Anemployer-operated eating facility for employ-ees is a facility that meets all the followingconditions.

1) You own or lease the facility.

2) You operate the facility. You are consid-ered to operate the eating facility if youhave a contract with another to operateit.

3) The facility is on or near your businesspremises.

4) You provide meals (food, drinks, andrelated services) at the facility during, orimmediately before or after, the employ-ee's workday.

Total meal value. The total meal value is150% of the direct operating costs of theeating facility. This total meal value is con-sidered the value of all meals provided at thatfacility for employees during the calendaryear.

Direct operating costs. The direct op-erating costs of an eating facility are the costsof food and drinks and the cost of labor for

employees performing services relating to thefacility primarily on the eating facility prem-ises. For example, the labor costs for cooks,waiters, and waitresses are included in directoperating costs. If an employee performs theservices both on and off premises, includeonly the labor c

Documents

US Internal Revenue Service: p535--1999