Contributors:
Deborah Walker | Compensation & Benefits Leader
Jacquelin LaClair | Manager, Government Contracting Industry Practice
Troy Clark | Manager, Tax Services
With the end of 2022, government contractors are starting their year-end close outs, reviewing costs, while considering Federal Acquisition Regulation (FAR) allowability and the potential tax implications. In this article, we address some of the frequently asked questions regarding payments of certain items that benefit employees.
Candidate Recruitment
Recruiting costs for the right candidate for your business can really add up. Candidate recruitment costs can involve allowable and unallowable costs, as described in FAR 31.205-34. The allowable portion of these costs includes help-wanted advertising, operation of an employment office needed to secure and maintain your labor force, educational testing programs, cost for employment agencies, and appropriate travel expenses for recruiting personnel and applicants for interviews. A contractor could face unallowable costs where help-wanted ads do not adequately describe the specific position or class of positions, or includes material not relevant to the recruitment process. From a tax perspective, candidate recruiting costs are entirely deductible for the employer.
Employee Relocation
Now that we’ve recruited our candidates, we may need to relocate them to be closer to our physical offices, if remote is not an option. Employment relocation costs must be closely monitored, since there are specific requirements in FAR 31.205-35 for determining which costs are allowable and unallowable, based on the employee’s individual situation.
For tax purposes, a primary downside is that the employee who receives the benefit of relocation that is paid on their behalf from their employer will need to recognize this as taxable income. The costs of relocating employees are deductible as compensation for the employer. Moreover, employers must include the relocation costs in the relevant employee’s W-2 wages.
Parking/Transit Passes
What other perks can a contractor offer its employees to ensure affordable commutes to the office? The costs associated with parking or transit passes should be deemed allowable under the general cost principles in FAR 31.201, although there is no cost principle that specifically addresses these costs.
The tax consequences of this benefit are a bit more involved. Employers are not allowed to deduct these expenses on the tax return. The employee is allowed to exclude up to $280 in parking and transit costs paid by their employer per month. Anything above this threshold is taxable income to the employee and deductible by the employer.
New Hire Gifts
Now, we’ve got our new hire ready to start with our business. Do they need a new mug, pen, t-shirt with our logo on it? Be prepared because these costs could be considered gifts under FAR 31.205-14 or advertising described in FAR 31.205-1, which will be deemed unallowable. From a tax perspective, as long as the gifts are de minimis, of so little value that it is unreasonable or impractical to account for, then amounts are not taxable to the employee and do not need to be reported.
Employee Gifts
How do we keep our current employees excited about the work we do? Is it time for a holiday gift card, gas cards for personal use or another mailable item? Unfortunately, the government does not want to pay for costs associated with employee gifts (see FAR 31.205-14) and they may be deemed unallowable. For tax purposes, gifts cannot be made to an employee. Such amounts are taxable compensation and deductible for the employer. A gift may be nontaxable if it is a “de minimis fringe” benefit, defined as those for which, considering its value and the frequency with which it is provided, is so small as to make accounting for it unreasonable or impractical.
Company-sponsored Team or Employee Organization
Are you interested in setting up an office baseball or dodgeball team? FAR 31.205-13 generally makes those costs allowable. These expenses are also deductible for tax purposes, and the employee does not have to recognize the income associated with any team uniform or the ability to be part of a team in a league.
Service Awards
For government contractors, acknowledging service or milestone awards to its employees can be allowable as an employee morale measure under FAR 31.205-13 or a bonus award under FAR 31.205-6(f). If it is a bonus, it will be important to have the award basis supported through an established plan or policy for the award that identifies the criteria used in making the determination.
For tax purposes, service awards are a deductible fringe benefit. The consequences to the employee are a bit more convoluted. Generally, awards are taxable as compensation to the employee, unless they can be excluded as a de minimis fringe benefit or an employee achievement award. An employee achievement award is one provided for safety or length of service. It is part of a program which provides awards of tangible personal property as part of a meaningful presentation. For qualified plan awards, which are part of a written program that doesn’t discriminate in favor of highly compensated employees, the benefit is nontaxable to the employee up to $1,600 per year. To meet the criteria of a “qualified plan,” the average value for all awards made to all employees must not exceed $400 per year. For nonqualified plan awards, the exclusion is $400 per year per recipient.
Cell Phone Reimbursements
Do you need a new cell phone or keyboard? Costs associated with the reimbursement of cell phones or other IT components are allowable if the employer can demonstrate its business use or purpose, although there is no specific cost principle that addresses these costs. These costs are deductible for tax purposes, and the employee does not have to recognize in income, so long as the cell phone is provided for a noncompensatory purpose (i.e., it is provided for business purposes).
Charitable Contributions and Donations
Charitable contributions or donations can be a tricky area regarding allowability. If the contribution or donation involves cash, property or services, it would be unallowable. The exception to this rule lies in FAR 31.205-1(e)(3), which involves costs for participation in community service activities being allowable except for FAR 31.205-1(f)(8), where costs associated with the donation of excess food to nonprofit organizations in accordance with the Federal Food Donation Act of 2008 would be deemed unallowable as well.
Corporations generally can deduct charitable contributions up to 10% of taxable income. Contributions that exceed that amount generally can be carried forward for 5 tax years. To qualify for this deduction, the contributions must be made to a qualifying organization.
Educational Assistance
Our employees want to learn more about our field and get the education for advancement opportunities. For the most part, FAR 31.205-44 makes training and education costs allowable but there are several exceptions such as:
- Where overtime compensation would be incurred
- Cost of salaries for attending undergraduate level or part-time graduate level classes during working hours
- Costs of tuition, fees, training materials and textbooks, subsistence, salary and any other payments in connection with full-time graduate level education is unallowable if the program exceeds two school years or the length of the degree program, whichever is less
- Grants to an educational or training facility
- Training or education costs for dependents not in primary or secondary level studies in foreign countries
- Contractor contributions to college savings plans for employee dependents
For tax purposes, the employer is allowed a full deduction for all expenses for providing educational assistance to their employees. The employee is allowed to exclude up to $5,250 of costs from their income. Amounts over this can possibly be excluded as a working condition benefit. To qualify for this, the property or services provided by the employer must be related to the business and not prepare the employee for a new profession. Additionally, the employer must also maintain required records to substantiate the business deduction.
Travel Costs
FAR 31.205-46 recognizes that travel costs are a part of doing business but separating the allowable portions from the unallowable portions can be tricky. Contractors have many options on ways to keep their travel accounts clean. Consider separating out the travel types (flights, meals, lodging and unallowable travel accounts), implementing allowability rules in the travel system and performing allowability testing sweeps of the travel accounts. Note that travel costs are governed by portions of three separate regulations depending on where the travel will take place. However, the entire regulations do not apply to contractors, but only those parts that relate to the maximum per diem rates, the definitions of lodging, meals and incidental expenses, and the regulatory coverage dealing with special or unusual situations are applicable to contractors.
Travel costs, other than meals, are fully deductible for the employer for tax purposes and are excluded from the employee’s income, so long as the travel costs are primarily serving a business purpose. The deduction for meal expenses is generally limited to 50%, unless the payment is for meals provided in a restaurant and is paid or incurred before 2023.
As the foregoing demonstrates, costs deductible for tax purposes are not necessarily allowable costs on government contracts. Consequently, government contractors have a lot to consider when offering fringe benefits to their employees. Superior fringe benefits can set aside a business as a desirable place to work. However, employers need to consider both the financial impact of their compensation packages, as well as the tax implications for their employees at an individual level.
