Qualified Employee Discounts

Jennifer Parmenter

by Jennifer Parmenter, CPA, Tax Manager

A frequent question we receive from veterinarians is “Can I provide discounts to my employees for products and services?” The answer is that you can provide this fringe benefit to your employees, and it can be tax-free to them if certain criteria are met.

First, let’s discuss what amount of discount is allowed in order for this benefit to be considered tax-free to the employee, per Internal Revenue Service guidance. For goods/products, the allowable discount can’t exceed the employer’s gross profit percentage. Example: Your cost to obtain product A is $85. You sell product A to your customers for $100. This is a 15% gross profit percentage (the sum of the $100 sales price less $85 product cost divided by the $100 sales price). The discount you provide to your employees on product A cannot exceed the gross profit percentage in order to remain tax-free to them.

For services, the discount can’t exceed 20% of the price of which the service is sold to customers in the normal course of business. Example: Your standard price for service B to regular customers is $100. You provide your employee with a 20% discount for service B, causing the employee to pay $80. If the discount for services exceeds 20%, then you will need to determine the portion that is taxable to the employee.

Next, let’s discuss who is eligible to receive these discounts. The Internal Revenue Service calls this particular fringe benefit a qualified employee discount, and it has provided guidance about who is considered to be a qualified employee. In fact, this discount is eligible to more people than you might initially think. Qualified employees are:

  1. Current employees

  2. Certain leased employees

  3. Partners performing services (if your business is a partnership)

  4. Retired or disabled former employees

  5. S-corporation shareholders that perform services and own more than 2% stock (if your business

    is a S-corporation)

  6. Widow(er) of deceased active or retired employees

Finally, the discount must be available to all employees (as described above), and not just to officers, owners, or other highly compensated employees.

In summary, discounts to employees are a great perk that your company can offer, and as long as the criteria above are met, the employee can receive these benefits tax-free.