Knowing the relevant fringe benefits regulations for clothing and clothing allowances provided to employees can help tax-exempt organizations reduce their tax burden and avoid potential penalties.
Employer-provided clothing is generally treated as taxable wages. However, there are two circumstances when it’s exempt. This includes when it’s:
- A de minimis fringe benefit under Internal Revenue Code (IRC) Section 132(a)(4)
- A qualified uniform which can be treated as a working condition fringe benefit under IRC Section 132(a)(3) and isn’t a personal, living, or family expense under IRC Section 262
De Minimis Fringe Benefits
Clothing is exempt as a de minimis fringe benefit if its value is small enough to make accounting for it unreasonable or impractical and if similar fringes aren’t provided frequently. This exception applies, for example, to t-shirts or hats given to employees at an event.
Working Condition Fringe Benefits
This exclusion allows an employer to provide property or services to employees on a nontaxable basis if the expenses would qualify for an ordinary and necessary business expense deduction if the employees paid for them. IRC Section 162 states, deductions are generally allowed “for ordinary and necessary expenses paid or incurred […]in carrying on any trade or business.”
Required clothing, such as a uniform, might fit that description, but the deductibility issue for clothing is complicated by IRC Section 262, which bars any deduction for “personal, living, or family expenses.”
Employer Requirements for Deductibility
The IRS has attempted to further clarify the working condition fringe benefits provisions by establishing rules permitting deductibility—and therefore a potential working condition fringe benefit exclusion—for clothing that’s:
- Required or essential to be worn as a condition of employment
- Unsuitable for everyday wear
The Tax Court has also applied an additional subjective test, requiring that the clothing isn’t actually used for general or personal wear.
Whether employees choose to wear their work clothes off the job is irrelevant for the second criterion. There must be something about the clothes that makes them unsuitable for everyday use, such as being covered with reflective materials in the case of construction workers’ uniforms. Clothing doesn’t cease to be adaptable to street wear—and won’t be considered deductible or excludable—simply because it has a company logo or other commercial writing on it.
An argument can also be made that even though clothing could be used for general purposes, clothing used only in work locations that isn’t available for employee personal use may not be taxable. Uniforms, for example, that are put on by the employee when they arrive at work, are taken off at the end of work, and are laundered and maintained by the employer aren’t available for general or personal wear, and so aren’t taxable fringe benefits to the employee.
Employee Requirements for Deductibility
Once clothing is determined to qualify as a uniform under these rules, the value and upkeep for the clothes provided is nontaxable to the employee. Similarly, the value of items such as safety shoes or boots, safety glasses, hard hats, and work gloves provided and maintained by the employer are nontaxable. Reimbursements to employees for their purchases of any of these are excludable if the expenditures are substantiated under the accountable plan rules.
If the items purchased with an employer-provided clothing allowance qualify for the de minimis fringe exception or the working condition fringe exception outlined above and the accountable plan rules are followed, the allowance won’t be taxable. However, this often isn’t the case. Allowances may be taxable for a number of reasons, such as:
- The employer has a policy that the clothing must be worn as a condition of employment, but the policy isn’t enforced
- Clothing available for purchase with the allowance isn’t limited exclusively to clothing that’s unsuitable for everyday wear
- An employee doesn’t follow the accountable plan rules to substantiate that clothing purchased meets the exception. In this case, even clothing that would meet the exception is taxable.
A taxable benefit also results when a contract includes a clothing allowance that isn’t used and isn’t restricted to nontaxable clothing. Under the constructive receipt doctrine in the Tax Code, income is evaluated for taxable or nontaxable treatment when all events to fix the amount have happened, and the employee has an unrestricted right to the allowance.
In this case, a clothing allowance isn’t constructively received if it’s:
- Only conditionally available
- Indefinite in amount
- Unable to be funded by the employer
- Subject to any other substantial limitation
An employee may refuse an allowance conditionally offered in order to avoid constructive receipt, but not one already included in an existing agreement.
To avoid a potentially taxable clothing allowance that may not be used, employers can consider the following options:
- Don’t include a stated amount of the allowance in the contract
- Make the allowance conditional upon a stated request of a particular amount by the employee and subsequent approval by appropriate management
- Require all clothing purchased with the allowance to be worn as a condition of employment
- Restrict the allowance to items unsuitable for everyday wear
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If you’d like to learn more about employer-provided clothing deductions and how they might be able to benefit your organization, please contact your Moss Adams tax advisor.