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Tax treatment of employer-provided outplacement services.

Recent economic conditions have caused many employers to cut back their work forces in order to remain competitive. Many of these employers are providing outplacement services to assist terminated employees to develop the necessary skills to obtain new employment. In Rev. Rul. 92-69, the IRS provided guidance on the taxability of such benefits to employers and employees for income and payroll tax purposes.

The Service concluded that the value of employer-provided outplacement services is generally excludible from an employee's gross income as a working condition fringe under Sec. 132(d) and, therefore, is not subject to FICA, FUTA or income tax withholding, provided that - the employer derives a substantial business benefit from the provision of the outplacement services distinct from the benefit it would derive from merely paying additional compensation to the employee, and - such outplacement services, if paid for by the employee, would be allowable as ordinary and necessary business expenses under Sec. 162.

The first requirement will usually be satisfied. According to the ruling, examples of substantial business benefits include promoting a positive corporate image, maintaining employee morale and avoiding wrongful termination suits. (It is not clear why the payment of additional compensation to a terminated employee would not achieve these same benefits.)

If the employer gives employees the option of receiving cash (or other taxable benefits) in lieu of the outplacement services, however, the value of whatever benefit the employee chooses (whether in the form of cash, outplacement services, etc.) becomes taxable as compensation to the employee. Worse yet, under constructive receipt principles (Regs. Secs. 1.451-1(a) and -2(a)), the value of the outplacement services, to the extent taxable, is includible in the employee's income for the year in which the services are made available, whether or not the employee actually receives any outplacement services during that year.

The second requirement for nontaxability - that the cost of the outplacement services, if paid for by the employee, would be deductible under Sec. 162 - will be satisfied as long as the outplacement services are designed to assist the employee in obtaining new employment in the same trade or business in which the employee is presently employed. This requirement will be satisfied even if the employee is not successful in obtaining new employment, provided the employee seeks employment in the "same trade or business."

Note that the value of employer-provided outplacement services that are taxable because they fail the first requirement may still be deductible by the employee as a miscellaneous itemized deduction (subject to the 2% floor), to the extent such outplacement services satisfy the second requirement (i.e., the employee obtains (or seeks to obtain) new employment in the same trade or business).

Although Rev. Rul. 92-69 will provide tax relief to many terminated employees receiving employer-provided outplacement assistance, the possibility still exists that some terminated employees may be kicked by Uncle Sam when they are already down. Although employees who are fortunate enough to receive employer-provided outplacement services in addition to their regular compensation will do so on a tax-free basis, those employees who must choose between outplacement services and severance pay (or other taxable benefits) will be taxed on the value of those services. These provisions can be especially harsh for employees who, after receiving employer-provided outplacement services, are unsuccessful in obtaining new employment, and find themselves subject to tax on the value of the services.

The "same trade or business requirement" could also pose serious problems for certain emrloyees. A terminated employee may wish to seek employment in a completely different line of work. Under Rev. Rul. 92-69, such employees will be subject to tax on the value of the outplacement services.

It is unclear whether employers have any responsibility to monitor the job search activities of employees to determine if the "same trade or business" requirement will be satisfied. An employer who learns that a former employee who received outplacement services sought employment in a different trade or business could face significant employment tax liabilities, unless the employer can establish that he reasonably believed that the employee was seeking employment in the same trade or business.

Conclusion

Providing tax-free outplacement services to employees can save an employer a potentially significant liability for employment taxes, and can also save terminated employees from the additional hardship of paying taxes on noncash fringe benefits. Employers that provide outplacement services to their terminated employees should carefully review the requirements of Rev. Rul. 92-69. From Dean R. Chmiel, CPA, Southfield, Mich.
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Author:Chmiel, Dean R.
Publication:The Tax Adviser
Date:Dec 1, 1992
Words:744
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