When a Tax-Free Employee Benefit Gets Taxed

A recent court case illustrates the need to pay attention to your timing when taking advantage of tax-free benefits.

In Voigt, T. C. Summ. 2018 – 25, an employee was laid off from the university he worked at in 1991. As part of the severance package from the university, he or his dependents could receive a certain amount of tuition waivers that corresponded to his years of service. The waivers had several limitations in place, but apparently not one specific limitation that would keep the taxpayer from using the waivers in 2013 — 22 years after leaving the university. 

He applied for the waiver for the spring and fall semester of 2013 (his daughter attended in years 2012 through spring of 2015) and he received a tuition waiver of $21,575. The university then issued a 2013 W2 the following year to report $21,575 of wages. The university also reported FICA withholding on those wages, for which the university billed the taxpayer to obtain reimbursement. The taxpayer did not report the W2 income on his return and received a deficiency notice.

2 Lessons About Taxable Income

The taxpayer had two arguments. Either the benefit was taxable in 1991, when the benefit was made part of the severance package, or that the benefit was excludable from income under Sec. 117. The Tax Court held that the tuition waiver was taxable in 2013, the year it was constructively received. The restriction that the waiver would only be available upon admission to the university made it impossible to include the benefit as income before such time that the daughter was admitted to the university (therefore not 1991). The Tax Court also did not agree with the taxpayer that the benefit was excludable from income under Sec. 117. To be excludable under Sec. 117, the taxpayer would have to be considered an employee of the university. Therefore, the benefit was taxable income.

This Year vs. Last Year

There is another lesson to be learned here. Apparently, the daughter also received a waiver for the Spring 2013 tuition in December of 2012. The university must not have issued a 2012 W2 and the IRS did not take issue with the fact that the tuition benefit was not included as taxable income for 2012. So the lesson here is that if you get away with something for one year, it does not mean you are safe from having something similar challenged in the following years.

Contact me today if you have questions or comments.

Susan A. Moussi, CPA, CFP®, CDFA SMD Tax & Divorce Financial Planning Consultants, Inc. Phone: 614.429.4172 susan@smdtaxanddivorce.com