By Hugh Mallon, President, Executive Compensation Concepts, Ltd.
If your head of school and other members of the senior leadership are considered highly compensated in the eyes of the IRS, your board needs to be aware of fringe benefits that may have unintended consequences. The IRS focuses upon discriminatory benefits offered to select management positions, with a cornerstone being the IRS definition of a highly compensated employee as someone who had compensation for the previous year in excess of the IRS code 414(q) limit ($115,000 for 2014-indexed), and/or is in the top 20% of the highest paid employees at the school. (See IRS “Publication 15-B (2014), Employer’s Tax Guide to Fringe Benefits.”) Here is a discussion of three fringe benefits commonly encountered in the independent school scenario.
Fringe Benefit 1: School Offers a Qualified Section 117(d) Tuition Remission Plan. Many schools offer a tuition remission plan, which may provide, for example, a 50% tuition subsidy for children of eligible employees who attend the school. What happens when highly compensated employees are given 100% tuition remission?
Taxation Consequence: The IRS code provides that gross income (e.g., W-2 wages) does not include a “qualified tuition reduction” that is part of a tuition remission plan provided that said plan does not discriminate in favor of highly compensated employees. However, in the event that highly compensated employees (head of school and/ or other highly compensated employees) receive a greater benefit than non-highly compensated employee, then all of the tuition remission provided to the highly compensated employee is included in his/her W-2 wages.
Fringe Benefit 2: School Offers a Group Medical Plan. Schools offer a group medical plan to all eligible employees whereby the school has a cost sharing subsidy toward the annual cost of the plan. For example, schools might cover 100% of the eligible employee or 75% of the family plan or some variation. What happens when these schools cover the full cost of the head of school and/or highly compensated employees’ spouse/family medical plan?
Taxation Consequence: In 2014, it is still an acceptable practice under the grandfathered health plan and, as a result, the school is not required to value the health benefit or payment of excess health benefit premiums for family health coverage above what is paid for all other eligible employees. However, once the Affordable Care Act is fully implemented, the nondiscrimination rules will apply. That is, the school will no longer be able to provide a greater benefit or percentage of the premium for the head of school and/or highly compensated employees than non-highly compensated employees on a tax-favored basis and the entire premium must be included as W-2 wages.
Fringe Benefit 3: School Provides Housing to Head of School. Consider the case where a school offers the head housing on campus or near the school.
Taxation Consequence: In order for the school’s head to exclude the fair market value of the arrangement from his/ her income, the school must meet certain requirements (known as Test for Exclusion-IRC Regulation Section 1.119-1(b)). There are three requirements: (a) employer furnishes lodging on the employer’s business premises; (b) employer furnishes lodging for the employer’s convenience; (c) employee accepts lodging as a condition of employment that is required to properly perform his/her duties. The failure to meet any one of these three lodging tests will require inclusion in gross income of the value of the lodging furnished by the employer to an employee.
To the extent that the school fails to meet the above requirements regarding lodging, the school head is taxed in the amount of the imputed value (e.g., 5% of FMV or rental value, whichever is less) of the house. The school must report this as W-2 wages to the head.
In addition to housing that is on the school’s campus, there are vast arrays of housing arrangements offered by independent schools that are beyond the immediate business premises. There is a need to assess the taxability to the school head. Schools in densely populated areas (e.g., Boston, Washington, DC, New York, Chicago, Philadelphia, Los Angeles, San Francisco, and similar metropolitan areas) have elected to take the position that if the housing offered is in close proximity to the school, then the housing provided to the head is a tax-free benefit.
Schools that provide housing not located on the school’s grounds face a catch-22 situation as to its taxability with no easy answer. The school must seek confirmation from its professional advisors (i.e., lawyer or CPA).