If you want to scare an employer, just say the words "Section 89."
That is the title of a new section of the Internal Revenue Code that was created under the Tax Reform Act of 1986 and became effective Jan. 1. In theory, the purpose of the new section is to prevent discrimination in benefits given to employees by an employer.But the complexities of the code are many, and employers - from small businesses to large city governments - are worried about complying with Section 89. For good reason, too.
Although the code became effective Jan. 1, the Internal Revenue Service has not issued guidelines for complying with the code; nevertheless, severe penalties can be levied against employers, and their employees, who do not comply with Section 89.
Churches or church organizations are exempt, however, and special exclusion rules apply to colleges and universities.
Employers trying to deal with Section 89 say they feel like players in a game that has no concrete rules; instead they've been given vague outlines of how the game is supposed to be played. However, as players they realize they may be penalized for not having played by the rules once the rules are created.
"Every company that has a benefits program should have someone monitoring this. It is going to be a major problem," said David Cherrington, president of the Personnel Association of Central Utah. "It is creating a lot of uneasiness. I attended a conference on it and was so disheartened - I couldn't even understand the tests involved."
There are two parts to Section 89.
The first requires employers to meet five requirements when offering benefits to employees - from health and accident plans to group life insurance to dependent care assistance:
-The plans offered must be clearly explained, in writing, to employees.
-Employees' rights under the plan must be legally enforceable.
-Employees must be notified of the benefits available under the plan, including consequences of being given a certain benefit, such as loss of a tax favorable option.
-The plan must be maintained for exclusive benefit of employees.
-The plan must be established with the intention of being maintained for an indefinite period of time.
If an employer fails to comply with these standards, all employees would be taxed on the value of received benefits. In addition, employers will be penalized if they fail to report on an employee's Form W-2 the value of benefits received as income.
"It is an administrative nightmare," said Michael Colledge, director of human resources at Dynix Inc. in Provo. If the penalties are enforced, "for example, if a widow receives a life insurance benefit of $200,000, that benefit payment would have to be taxed. The tax comes on the portion (of the benefit) actually paid out. If a family has received $100,000 in health care for a child, that would be counted as income and would be taxed. Talk about a great way to alienate your employees."
The second part of Section 89 requires employers to perform a series of complicated tests to determine whether highly compensated employees receive "excess" benefits not offered to other employees.
Employers are required to make this determination using one of several tests outlined by Section 89, and must take into consideration employees who work more than 17.5 hours per week. If highly compensated employees are receiving "excess" benefits, employers must report that excess as income to the IRS and to the employee. The employee, in turn, must count the value of those excess benefits as gross income for tax purposes.
In practice, the reaction to this part of Section 89 has taken several forms.
"One company in Salt Lake City terminated their benefits package because of the complexities involved in trying to comply," Cherrington said.
"Frankly, most companies will gross up the salaries of the highly compensated employees," Colledge said. That is, companies will pay these employees more because of the fact that these employees will have to pay higher taxes on their excess benefits.
And, part-time employees may be limited to 17.5 hours per week to prevent the lesser amount of benefits offered to such employees from skewing the tests ratios.
"That hurts the very people that this was supposed to benefit," Colledge said. "We have two options - gross up or draw back our part-time people. Either way, it will cost us (employers) more money."
One way or another, it appears to many employers that the real purpose of Section 89 is not to equalize benefits but to raise additional tax revenue.
"It (Section 89) has nothing to do with not wanting highly compensated employees to not be favored," Colledge said. "What they (Congress) are really trying to do is raise revenue."
Cherrington agrees. "The point of the law was an attempt by Congress to increase taxation by closing down one of the loopholes used to transfer money to executives without their having to pay taxes on it - through benefits packages such as company cars, stock options, etc. Congress closed down the automobile loophole, now they are trying to close other loopholes."