CORPORATE
Determining the Taxable Nature of Employer Gifts

In late February, celebrities crowded the Kodak Theatre in Hollywood to present the annual Academy Awards. In past years, the ceremony’s sponsors gave the presenters, performers and winners gift bags, or “swag,” each valued in excess of $100,000, to help ensure a star-studded turn-out.

Starting this year, celebrities no longer received gift bags after the IRS recently cracked down on the practice, stating that the bags were not gifts, but “non-cash compensation,” which would require the recipient to pay income taxes based on the value of the bag’s contents.

Establishing the Intent of the Giver
Most people can only dream of receiving such a “gift.” Nevertheless, the Academy Awards example holds an important lesson for employers about gifts and other perks to employees. Central to the issue of whether a gift is tax-free is the intent of the giver. To qualify as a tax-free gift, the exchange must grow out of affection, respect, admiration or generosity. In the case of the Academy Awards, the gift bags serve as enticements for the celebrities to appear at the ceremony. There is a business purpose for the bags; hence, they are taxable.

Typically, employers’ gifts to their employees don’t qualify as tax-free and are treated as additional taxable compensation. The exception to this rule is when the gift has nominal value. In such cases, the nominal gifts are exempt from federal employment taxes.

Defining Nominal
As always in matters of taxation, the devil is in the definition. In this case, it is the meaning of “nominal.” The IRS doesn’t provide a dollar threshold for nominal gifts. Instead, in order to be considered nominal, a gift must satisfy these requirements:

• The gift promotes good will or health.
• The gift is not cash.
• Accounting for the gift would be impractical.
• Gifts are given infrequently.

Based on those criteria, some of the benefits and perks that are considered nominal for tax purposes are: occasional company parties or picnics; free coffee and pastries; flowers, fruit or similar items provided to employees in times of illness or for special recognition; traditional holiday gifts, such as turkeys at Thanksgiving or hams at Christmas; and occasional tickets to theater or sporting events.

When the value or frequency of the gifts to employees increases, it tends to be considered part of total compensation and therefore taxable. For instance, season tickets to theater or sporting events; a country club membership; weekend use of an employer’s hunting lodge or boat; and gift certificates redeemable for cash would all be taxable.

Job-Related Perks
However, there are instances when valuable perks are required due to the nature of the job and are exempt from taxation as compensation. These include:

Meals: To be tax-free, meals provided to employees must be offered at the company’s place of business, and the meals must be considered a “convenience” to the employer. The employer’s convenience test can be met if, for example, the lunch period is short or there are no eateries within a reasonable distance or when providing dinner for employees working late.

Refreshments: Like occasional event tickets or company picnics, employer-provided coffee and donuts fall under the category of de minimis fringe benefits that are not taxed.

Job-related perks and gifts are proven morale-boosters for employees. Employers, however, need to be careful in determining whether those perks or benefits expose the company, as well as the employee, to a tax liability, thereby eroding the goodwill they generate.

For more information, please contact Peter Orfanakos at porfanakos@gellerco.com.

FEDERAL
E-Filing: The Future Is Now

Increasingly, corporate tax returns are being delivered with the click of a mouse rather than by courier. This year, more corporate returns will be filed electronically than ever before. For tax years ending on or after December 31, 2006, the Internal Revenue Service is requiring corporations and tax-exempt organizations with $10 million or more in assets (as shown on Schedule L of their Form 1120 or 1120S and the corresponding balance sheet for tax-exempt entities) and filing at least 250 returns (which include W-2s, 1099s and quarterly employment tax returns) annually to file their returns electronically. The requirement applies to both C and S Corporations, as well as all tax-exempt organizations, but not partnerships. As a result, the IRS expects more than 20,000 large corporate taxpayers and as many as 10,000 tax-exempt entities to file electronically this year.

States Begin E-Filing Requirements
Not to be left behind, states are getting in on the act. This past summer—after a long wait for vendors to develop e-filing software and for states to certify the software—the first state returns were processed under a voluntary 1120 federal-state program involving more than two dozen states.

As might be expected, not all states are moving at the same speed. A few states, including Massachusetts and Connecticut, have mandated corporate e-filing or offered their own options, while others, such as New York, New Jersey and California, are poised to do so. Here is a rundown of two of the mandated states:

• As of January 1, 2006, Massachusetts required corporations with gross receipts of $100,000 or more to file and pay their corporate excise tax electronically.
• Connecticut requires e-filing and payment if the previous tax year’s tax liability was greater than $10,000 and the taxpayer is notified by the Department of Revenue.

E-Filing Benefits
Both federal and state requirements include provisions so that corporations and tax-exempt organizations can opt out of having to file electronically, even if the requirements for e-filing are met. Waivers are available for those taxpayers not able to get in compliance with the e-filing requirements, and further guidance, including examples about situations where a waiver would or would not be granted, can be found in IRS Notice 2005-88.

Nevertheless, there are certain benefits for the taxpayer when e-filing. For instance, returns that are e-filed are processed faster, so that problem areas are identified more quickly and refunds are processed sooner. While some pundits have suggested that e-filing increases the odds of a tax audit, there is no evidence that such a relationship exists.

The e-filing die has clearly been cast and even if corporations aren’t required to file for state corporate returns electronically this year, they should be prepared to do so in the future. Now is the ideal time for corporate filers to review their compliance procedures so that their electronic filings will be complete and accurate.

For more information, please contact Peter Orfanakos at porfanakos@gellerco.com.

INDIVIDUAL
Sharing the Wealth, Family-Style, with FLiPs

Many families with substantial assets are rediscovering the virtues of a 40-year-old legal structure, the Family Limited Partnership (FLiP), as a means of shifting assets between generations with minimal tax consequences. The renaissance in FLiPs can be traced to a 1993 IRS clarification specifically making gifts of stock to family members eligible for minority valuation discounts.

FLiP Structure
Usually, a FLiP consists of a partnership that holds assets, such as a family business, income-producing real estate or even a portfolio of securities. One parent serves as the general partner while the children or grandchildren are the limited partners. As general partner, the parent has full and complete control over the assets and can gift as many of the limited partnership units to the children as desired. As limited partners, the children cannot participate in partnership decision-making without jeopardizing the partnership’s tax status. This means that they cannot have a hand in investment decisions, hiring managers, determining the timing or amount of partnership distributions or dissolving the partnership. In addition, their ability to sell their partnership interest typically is restricted, often by the general partner’s right of first refusal on the sale.

Due to the children’s inability to participate in managing the assets and the narrow market for the children to sell their partnership interests, the value of FLiP interests is worth significantly less for transfer tax purposes than the underlying assets in the partnership. Lack of marketability and minority interest discounts can reduce the value of the interest for transfer tax purposes. It is this discounted value (which can be as high as 50%, depending on the circumstances) that allows parents to accelerate the shifting of their assets to their children for estate planning purposes using the annual gift tax exclusion and the lifetime unified credit.

FLiP Benefits
Another attractive aspect of the FLiP structure is that as general partner, the parent can maintain full control over the assets or business even if the parent retains as little as a 1% equity stake in the partnership. A further benefit is that the FLiP may limit the children’s exposure to liability claims and protect the assets from events, such as personal bankruptcy of a child. In such a situation, often the most that the child’s creditor can expect is receipt of periodic partnership distributions.

Parents can also steer future control over their family’s assets by directing disposition of the general partnership interest through their wills. However, under many state laws, a partnership terminates with the death of the general partner. The surviving partners would have to agree to continue the partnership, something which cannot be guaranteed. To ensure continuity, parents might consider either incorporating a continuation provision into the partnership agreement, which would provide for the partnership continuation in the event of the death of the parent, or by structuring the limited partnership with a corporate general partner. The parent would own the stock of the general partner so the partnership would not terminate upon his or her death.

In addition, FLiPs can be adapted to a family’s particular circumstances. Sometimes the tables are turned, and it’s the younger generation that acts as the general partner. In these cases, it is the children who are running the business and the parents who are the limited partners due to age or infirmity.

A cautionary note is in order: FLiPs are complex, aggressive strategies, and lately the IRS has been scrutinizing FLiPs closely for abuses. FLiPs should be used only for legitimate business purposes. A FLiP cannot be formed simply to reduce taxes or dodge creditors. Taxpayers should consult with their attorney and tax advisor about the appropriateness of a FLiP for their situation.

For more information, please contact Sherry Reisch at sreisch@gellerco.com.

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The information contained in TaxView is for general purposes only and is not intended, and should not be construed, as legal, accounting, or tax advice or opinion provided by Geller & Company to the reader. This material may not be applicable to, or suitable for, the reader’s specific circumstances or needs. Therefore, the information should not be used as a substitute for consultation with professional accounting, tax, or other competent advisors.