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Discounted veterinary care as an employee benefit: What you need to know

2020-12-9 GettyImages-184960288 Heinke pet care employee benefits - blog.jpg

The issue of veterinary care for employees’ animals at reduced rates is a confusing and emotional topic. Employees highly value veterinary care as a benefit. Both employers and employees want to give and receive free or highly discounted services and products. But at what point do discounted veterinary services or products and medications become taxable compensation rather than a nontaxable fringe benefit?

A significant portion of the practice revenue pie is served out as worker compensation, in the form of wages and salaries, payroll taxes, and a litany of employee fringe benefits, which are defined by the Internal Revenue Service (IRS) as a form of employer pay for a worker’s performance of services.

Practice administrators often struggle with questions about legally allowed fringe benefits. Regulatory guidance is often vague when it comes to specific facts and circumstances. Law changes frequently expand or contract what was previously acceptable. Antidiscrimination considerations further affect employer flexibility in determining what fringe benefits can or will be offered.

The Internal Revenue Code (IRC) and federal tax and labor regulations include a complex series of rules that control how benefits must be offered. For example, some fringe benefits may be excluded from an employee’s gross income whereas others may not, and count as taxable compensation that must be included in payroll.

This is what practice administrators need to know when deciding how to give benefits of any kind and of any value: The government basically says, “assume all benefits must be included as taxable compensation, as they essentially equate to payments made to workers in exchange for their work.”

Any fringe benefit an employer gives a worker (or even a member of the worker’s family) is taxable to the worker, unless the law specifically excludes it.

In general, a veterinary practice must include in a worker’s pay the amount by which the value of a fringe benefit exceeds the sum of:

  1. the amount, if any, the employee paid for the benefit, and
  2. the amount, if any, specifically excluded by some provision of the law [Reg. Section 1.61–21(b)(1)]

If the worker is a practice employee, this excess amount is reported through payroll and then captured as taxable income on the employee’s W-2. If the worker is an independent contractor, the benefit value is included on Form 1099-NEC (new for the 2020 year; prior to 2020, the amount would have been included on Form 1099-MISC). If the worker is a partner, the benefit is reported on Schedule K-1 (Form 1065), Partner’s Share of Income, Deductions, and Credits, etc.

Unfortunately, there is no specific list of what a veterinary employer can discount or even give to workers for free. Practice administrators must learn the broad regulatory guidance and then adapt their policies to what they believe can be defended as reasonable in light of facts and circumstances. Managers must also stay up to speed on law changes that require policy modification as time rolls on because worker policies are rarely static.

IRC Section 132 identifies noncash fringe benefits that can qualify for exclusion from an employee’s gross income. IRS Publication 15-B (2020), Employer’s Tax Guide to Fringe Benefits summarizes basic rules. The three types that may pertain to discounted veterinary care include:

  • no-additional-cost services
  • de minimis (minimal) fringe benefits
  • qualified employee discounts

No-additional-cost services

If a service fails the no-additional-cost definition, it will likely be eligible for a qualified employee discount of up to 20% of the client fee. Most employee veterinary care will fall into this latter employee discount category.

The IRS publication states no-additional-cost services (NACS) can generally be excluded from wages, but be aware: the application is very limited. This service exception was litigated by the airline industry to allow airline employees to fly free if seats would have been empty otherwise. Merely add the fact that an employee can reserve a seat, and the service no longer fits the exception: the ticket value becomes taxable compensation.

The IRS describes NACS as services offered for sale to customers in the ordinary course of the line of business in which the employee performs substantial services. The exclusion applies when the practice incurs no substantial additional cost in providing such service to the employee, determined without regard to any amount paid by the employee for such service. Any lost revenue must be counted as a cost.

NACS are excess capacity services. The IRS examples are airline, bus, or train tickets, hotel rooms, or telephone services provided for free or at a reduced price. The practice is considered to incur substantial additional costs if you or your employees spend a substantial amount of time providing the service, according to the IRS, “even if the time spent would otherwise be idle or if the services are provided outside normal business hours.”

This last consideration seems to eliminate most examples of veterinary care that, at first glance, appear to be reasonable examples of NACS, such as providing an employee pet’s physical examination when a client cancels at the last minute or spaying a pet after hours.

Perhaps an allowed veterinary NACS would be permitting an employee to board a pet without a reservation to hold a kennel spot? This example seems to fit within the meaning of excess capacity. Again, remember that the government will come down on the side that says this is a form of taxable compensation. And service frequency, addressed in the next section, could help defeat the premise of nontaxability.

De minimis (minimal) benefits

Under Section 132(e), de minimis fringe benefits are defined as any property or service where the value is so small that it makes accounting for it unreasonable or administratively impractical.

An example of a de minimis fringe benefit might be a cursory physical examination of a healthy pet before vaccination, although some would argue any level of veterinary examination, regardless of brevity, has value that is not small.

When determining the value, you must consider the frequency with which similar services are provided by the employer to the employee. If an employee has multiple pets who receive several examinations in a year, the frequency term of IRC Section 132(e) is violated. The services would therefore be subject to, at best, a 20% discount (see the next section, qualified employee discounts discussion). You must use your best judgment in determining what constitutes a de minimis fringe benefit within the meaning of value, cost, and frequency.

As an aside, the de minimis rule also specifically states that any kind of cash or cash equivalent (gift certificates, gift cards, credit card use), no matter how small, can never be excluded from an employee’s taxable compensation.

De minimis benefit examples included in Publication 15-B illuminate how a veterinary practice could find certain services that might fit this rule. The publication states as an example, “occasional personal use of a company copying machine if you sufficiently control its use so that at least 85% of its use is for business purposes.” Therefore, would a practice be able to take the position that employee use of a therapy laser for a limited number of pet treatments would fit into the de minimis category? Perhaps.

Do free goods from vendors, such as parasiticide medications that are intended for distribution to practice employees, fall within the de minimis category?

Taking a conservative viewpoint, are free goods in a significant quantity to be more appropriately considered a form of vendor-provided discount that should be netted against all purchases of the same type?

Current authoritative literature is silent on these kinds of fact-specific questions. Practice administrators will need to make their own decisions.

Qualified employee discounts

A qualified employee discount is any employee discount involving veterinary business property or services sold to nonemployee clients. The rules are different, depending on whether medication or other inventory is dispensed as compared to the veterinary services provided.

In the case of property (goods), the employee discount cannot be more than the gross profit percentage of the price at which the property is offered to the client.

For a product to be sold on a gross profit basis, the actual cost of the property, plus any additional cost for holding or ordering, would have to be included in the calculation. As a rule of thumb, increase the cost of the product by at least 10% to cover the holding and ordering costs, and establish an employee purchase price. The concise calculation: the employee discounted price equals vendor price multiplied by at least 1.10.

For veterinary services, the discount cannot be more than 20% of the price at which the service is being offered by the practice to its nonemployee clients (IRC Section 132(c)(1)(B)). The bulk of services valued and used by veterinary employees will be subject to this discount rule.

Service or product dilemmas

In the land of veterinary medicine, much pricing involves services wrapped around a product. The price of a vaccination procedure includes the veterinarian’s knowledge, expertise, and the act of administering the vaccine.

In general, if the vaccines, needles, and syringes were not sold to the employee at a 10% markup for the employee to administer, then the discount rule of no more than 20% of regular customer price likely applies.

What about reference laboratory tests that the lab provides without charge to the veterinary practice for its employees?

The price of a laboratory test almost always encompasses services of sample acquisition and veterinarian interpretation of the results, wrapped around the reference lab fee. It appears that the discount rule of 20% of the regular customer price pertains. Alternatively, is there a defensible position to subtract the usual reference lab cost (albeit free for employees) from the regular customer price, and discount the resulting service component by 20%?

Again, current authoritative literature is silent on these questions. Practice administrators will need to make their own best decisions when it comes to services wrapped around a vendor’s free deal.

Discounts greater than the rules

What happens when there is a violation of the 20% discount rule, the de minimis rule, or when property is sold to the employee at less than 110% of the cost from the vendor?

In every instance, the difference between the minimum that should be charged in accord with the rules and what the employee actually paid must be included in the employee’s wages as additional taxable compensation. All mandated tax amounts must be withheld from the value of these gratis services and inventory giveaways.

Antidiscrimination rule

A fringe benefit program may not discriminate in favor of officers, owners, and highly compensated employees. If the nondiscrimination test is not met, the fringe benefit can be excluded from taxable compensation only by those employees who receive the benefit and who are not members of a favored group.

As an example, if you provide nonveterinarian staff a 15% discount and veterinarians a 20% discount, all nonveterinarian staff may exclude the 15% discount from wages; however, the veterinarians must report the entire 20% of their discount as taxable wages.

Discounts given to family members of the employee are treated just as if they were provided directly to the employee. Family members include spouses, dependent children and stepchildren, and certain dependent foster children.

Employer-provided pet or equine insurance

Employers can pay premiums for companion-animal insurance and offer it as a benefit. However, unlike human health insurance, pet/equine insurance is a taxable benefit. The premium value must be included in the taxed wages of the employee. Consequently, the insurance cost is deducted by the practice as employee wages.

Gross up taxes or not?

If the amount of discounted services is determined to be taxable, such as when the discount is more than the legally allowed amount, you need to determine how the practice will handle the excess discount as it is included in payroll. Advance employee communication of expectations is essential, such as through written policy or employee handbooks.

The practice’s two options are:

  1. Simply add the excess discount amount to other taxable wages and withhold the same amount from the total resulting after-tax compensation paid during that pay cycle. Note that the taxes assessed on the benefit are passed to the employee: the income taxes and employment taxes on benefit value will be netted against the other wages paid, resulting in lower net pay than the employee would otherwise expect.
  2. Include the excess discount amount in wages after “grossing” it up: the value of the benefit is increased to cover the tax-withholding effect, which the employer effectively subsidizes and pays.

Comparing gross up versus no gross up of employee payroll taxes

 

Gross up

No gross up

Value of taxable benefit

$100.00

$100.00

Add employee taxes covered by employer

$29.28

Gross wages

$129.28

$100.00

Federal and state tax withholding*

($19.39)

($15.00)

Social security and Medicare (7.65%)

($9.89)

($7.65)

Withhold the value of benefit

$100.00

$100.00

Balance

($22.65)†

*15% in this example

†Must be deducted from other wages paid

Conclusion

The simplest, most direct management approach to employee veterinary care discounts is to follow the IRS’s qualified employee discount guidance:

  • Discount on services = no more than 20% of nonemployee client price.
  • Discount on products and medications = 1.1 times the amount paid to the vendor.
  • Ensure that there is no discrimination between worker types or classifications.

While most veterinary practice owners would like to reward loyal, hardworking employees with free or deeply discounted animal care, the law is clear. When you consider the ramifications of not recognizing generous discounts as a form of taxable compensation, the decision is easy.

If an agency audit disclosed large-value worker discounts that were then subsequently reclassed as wages, the practice would be responsible for all delinquent payroll taxes that should have been withheld but were not, in addition to matching employer social security and Medicare contributions, federal and state unemployment taxes, and workers compensation premium adjustments. If the practice sponsors and pays into a retirement plan, it would also be hit with penalties for inadequate contributions. In all cases, penalties and interest would almost certainly be assessed by the IRS, Department of Labor, and state agencies.

In the end, this is the best advice: pay your employees well and fairly for the work they provide so that they can make a fair exchange for the veterinary services they require for their own four-legged companions.

Photo credit: ©barisonal/E+ via Getty Images