IRS proposes updates to line of business rules

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The IRS issued proposed regulations (REG-132805-17) in August that would update how employers determine their “line of business” when applying the income exclusion for no-additional-cost services and qualified employee discounts under Section 132.

The proposed regulations would replace the current Enterprise Standard Industrial Classification (ESIC) Manual, which has not been updated since 1974, with the North American Industry Classification System (NAICS), a more current and widely used system updated every five years (most recently in 2022). This change is intended to more accurately reflect current economic activities and simplify compliance for employers, particularly in industries that did not exist in 1974.

An employee’s taxable compensation for services generally includes anything of value provided by an employer, including non-cash fringe benefits, except to the extent the fringe benefits are specifically excluded under the tax code (or the employee pays the fair market value for such benefits). Sections 132(a)(1) and (2) exclude from taxable compensation any fringe benefit that qualifies as a no-additional-cost service or a qualified employee discount, respectively, among other specific exclusions under that section.

For this purpose, a “no-additional-cost service” is generally defined to include certain services an employer provides an employee if those services are offered for sale to customers in the ordinary course of the line of business in which the employee is performing services. A “qualified employee discount” is generally includes certain employee discounts with respect to property (other than real property and other than personal property held for investment) or services that are offered for sale to customers in the ordinary course of the line of business in which the employee is performing services.

Under the proposed regulations, an employer’s line or lines of business would be determined using the four-digit NAICS industry group level rather than the two-digit ESIC codes as the industry classification system.

The proposed regulations also would make minor modifications to the current aggregation rules that apply when an employer operates in more than one line of business. If certain conditions are met, these aggregation rules allow employers with multiple lines of business to essentially treat them as a single line of business for certain purposes. For example, the rules can apply where single lines of business are commonly operated together and employees perform substantial services across multiple lines of business. 

The proposed regulations would modify one of these aggregation rules to reflect the expanded types of retail operations that are now prevalent. The current rule allows multiple lines of business to be treated as a single line where the employer’s retail operations are located on the same premises and would be considered one line of business if the merchandise offered for sale in such lines of business was offered for sale at a department store. The proposed regulations would replace “department store” with “general merchandise store, including warehouse clubs and super centers.” The IRS explained that this update reflects the pervasiveness of big-box stores, hypermarkets, super centers and warehouse clubs in the current retail economy, especially in comparison to the traditional department store.

The regulations are proposed to apply to tax years beginning on or after the date the rules are published as final regulations in the Federal Register.

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