De minimis and working condition fringe benefits reexamined.

In American Airlines, Inc., 204 F3d 1103 (2000), aff'g and rev'g 40 Fed. Cl. 712 (1998), the Federal Circuit agreed with a Court of Federal Claims ruling on the tax treatment of gift vouchers and certain per-diem allowances that did not qualify as working condition fringe benefits. However, the appeals court did not agree with the lower court's grant of summary judgment for per diems given on overnight trips (i.e., travel requiring at least one overnight stay away from an employee's home base) and remanded the case for further findings of fact on whether American Airlines "reasonably expected" the amounts paid in per diems to its flight crew to be incurred.

Background

From 1985-1988, American Airlines provided a $36 per-diem allowance to its flight crew and flight attendants, for meals and incidental expenses while away on overnight and turnaround trips (i.e., travel involving departure and return to a home base on the same day). American Airlines considered several factors in determining the per-diem amount, including industry standards, the experience and judgment of its management, Federal per-diem rates ($14/day) and cost estimates prepared by a consulting firm. Per-diem amounts were separately identified on employees' paychecks. American Airlines did not require its employees receiving per diems to substantiate their actual travel expenses.

American Airlines also provided its flight crew (e.g., pilots and engineers), based in Dallas-Fort Worth (DFW), eight hours of this per-diem allowance for each day of training at the DFW facility. In addition, union contracts required the airline to provide onboard meals for pilots and flight engineers on certain flights.

In 1985, a major competitor's labor strike increased American's passenger loads, which resulted in an increase workload on its employees. As a gesture of appreciation, American Airlines gave each employee two $50 "Be My Guest" American Express restaurant vouchers. The employees' names were not included on the vouchers, and there were no restrictions on transferability. If the purchase was less than $50, no refund was given.

American Airlines' Position

American Airlines did not treat the benefits as wages and, therefore, did not withhold employment taxes, relying on the following arguments:

                    American Airlines'
Benefit             Position

Per Diem--          Travel expense
Overnight Trips     exclusion provided
                    under Regs. Secs.
                    31.3121(a)-1(h)
                    and 31.3401(a)-1(b)(2)
                    and/or
                    "working condition
                    fringe benefits" under
                    Sec. 132(a)(3)

Per Diem--Day       Conceded these
Trips and In-Town   allowances were not
Training            excluded in and of
                    themselves, but relied
                    on the Rev. Rul.
                    69-592 "annual
                    netting rule"

On-board Meals      Provided for the
                    "convenience of the
                    employer" under
                    Sec. 132(a)(3)

Gift Vouchers       De minimis fringe
                    benefit under
                    Sec. 132(a)(4)

The IRS's Position

On audit, the IRS concluded that American Airlines should have treated each benefit as wages and withheld the appropriate employment taxes. The Service concluded that tax was due on (1) one-sixth (or $6) of the $36 per diem for overnight trips, (2) all the per diem for turnaround trips and training days, (3) $10 for each onboard meal and (4) the full face of the vouchers.

The IRS issued an assessment and American Airlines paid the full amount and filed employment tax refund claims. The Service disallowed the claims, and the airline filed a refund action in the Court of Federal Claims.

Court of Federal Claims

The court granted summary judgment in favor of the IRS. It held that the per-diem payments for overnight trips were not excludible from wages, because American Airlines had not shown that they were based on expenses reasonably expected to be incurred and, therefore, did not meet the definition of "wage" under Regs. Secs. 31.3401(a)-1(b)(2) and 31.3121(a)-1 (h). Further, the court concluded that, in the absence of substantiation, $14/day (the Federal per-diem rate at that time) was the objectively reasonable amount for meal expenses. Thus, $22 (the amount paid over $14/day) should be treated as taxable wages. The court also rejected American Airlines' argument that the per diems should be treated as working condition fringe benefits under Sec. 132(a)(3), because such treatment would require that the employer substantiate the amount of such expenses or have a reasonable belief that employees were keeping adequate records to substantiate their expenses over $14/day under the requirements in Sec. 274(d). Thus, the only amount that qualified as a working condition fringe benefit was the $14 Federal rate, which was deemed reasonable in the absence of substantiation.

The court also held that the per diems for turnaround trips and training were not excludible from wages, because the payments did not meet the requirement that they were "reasonably expected to be incurred." The court also held that these were not working condition fringe benefits, because such payments were not deductible under Sec. 162(a)(2).

The court held that American Airlines could not rely on the Rev. Rul. 69-592 netting rule, because it applies on an employee-by-employee basis: i.e., it allows an employer to exclude particular nonovernight travel allowance payments only when the employer (at the time of the payment) reasonably believes that particular employees will incur deductible travel expenses during the year in excess of the employer's travel allowance payments. American Airlines did not produce any documentation to show that it could reasonably believe that this was the case.

For on-board meals, the Service conceded that they were not wages subject to withholding, because, under Sec. 119, they qualified as meals provided for the employer's convenience. However, because the per-diem amounts that should have been treated as taxable to the employees was $22/day instead of $6/day, the IRS asked for an offset of the additional taxes owed against the taxes paid for the on-board meals.

The court also held the gift vouchers were not excludible from wages as de minimis fringe benefits, because American had not shown that it was administratively impractical for it to account for the vouchers. Every employee received two vouchers totaling a face value of $100, and this amount could have easily been included in every employee's paycheck.

Federal Circuit

American Airlines appealed the Court of Federal Claims decision, claiming that the court erred in holding that (1) certain per-diem payments were not excludible from wages as travel expense payments; (2) certain per-diem payments were not excludible from wages as working condition fringe benefits; and (3) the American Express vouchers were not excludible from wages as de minimis fringe benefits.

The Federal Circuit affirmed the lower court's decision that the per-diem allowances did not qualify as working condition fringe benefits. However, the Court of Appeals reversed and remanded the issue of whether the travel expense regulations applied to American Airlines' per-diem allowances during the years at issue. The Federal Circuit affirmed the lower court's grant of summary judgment on the taxability of the vouchers.

Implications to Employers

American Airlines serves as a reminder that the de minimis fringe benefit exclusion of Sec. 132(a)(4) is very narrowly defined and is intended to be a rule of administrative convenience to relieve employers of having to trace small, infrequently provided benefits.

In addition, the decision reiterates that substantiation requirements must be met to exclude reimbursements of travel expenses as working condition fringe benefits.

FROM KIMBERLY A. BUTLER, J.D., CPA, COCA-COLA ENTERPRISES, INC., WOODSTOCK, GA

Editor's note: Mr. Ely is the immediate past chair of the AICPA Tax Division's Relations with the IRS Committee. Ms. Butler and Mr. Oveson are committee members.