Employer-paid expatriate tax-return preparation is taxable compensation

Plain-English summary

A U.S. employer paid a multinational accounting firm to prepare domestic and foreign tax returns for employees on international assignments as part of a tax-equalization program. Chief Counsel concluded that return preparation directly satisfied the employees' personal filing obligations and was not a working-condition fringe benefit under IRC Section 132(d). The fair market value of the services was taxable income, and the accounting firm's arm's-length charges were a reasonable measure when better market evidence was unavailable. That value also counted as wages for FICA and federal income-tax withholding. Limited withholding exceptions could apply if the employer reasonably believed Section 911 excluded the amount or foreign law required withholding, while separate employer tax-equalization calculations remained excludable.

Ruling snapshot

• Question: How should employer-paid domestic and foreign tax-return preparation for internationally assigned employees be taxed and valued?
• Outcome: advice given
• Key authorities: IRC §§ 61, 132(d), 162, 212(3), 911, 3121(a), 3401(a), 3402(a)(8); Treas. Reg. § 1.61-21(b)

Full text (IRS public release)

       Office of Chief Counsel
       Internal Revenue Service
       memorandum
       Number: 201810007
       Release Date: 3/9/2018
       CC:TEGE:EOEG:ET2
       POSTN-135283-17

UILC: 132.00-00

date: November 28, 2017

 to:   Jeremy H. Fetter
       Supervisory Trial Attorney
       Division Counsel
       (Tax Exempt and Governmental Entities)

from: Lynne A. Camillo, Chief
Employment Tax Branch 2
Associate Chief Counsel
(Tax Exempt and Governmental Entities)

subject: Tax Treatment of Employer-provided Tax Preparation Services as Part of Employer's
International Tax Equalization Program

       This Chief Counsel Advice responds to your request for assistance. This advice may
       not be used or cited as precedent.

       LEGEND

       Taxpayer              = ----------------
       CPA Firm              = -------------------------------------
                               -------
       Year 1                = -------------------------------------
       Year 2                = -------------

       ISSUES

                (1)   Are the tax preparation services that Taxpayer provides for the benefit of
                      its employees working in foreign countries includable in the employees’
                      gross income?
                (2)   If the tax preparation services are includable in gross income, how does
                      Taxpayer determine their value for purposes of imputing income to the
                      employees?

POSTN-135283-17 2

   (3)    Does the value of the tax preparation services constitute “wages” for
          Federal Insurance Contributions Act (FICA) tax purposes?
   (4)    Does the value of the tax preparation services constitute “wages” for
          purposes of federal income tax withholding (FITW)?

CONCLUSIONS

   (1)    The tax preparation services provided by Taxpayer for the benefit of its
          employees working in foreign countries are includable in the employees’
          gross income.
   (2)    The amount includable in the employees’ gross income is the fair market
          value of the tax preparation services.
   (3)    The fair market value of the tax preparation services constitutes wages for
          FICA tax purposes.
   (4)    The fair market value of the tax preparation services constitutes wages for
          purposes of FITW, unless Taxpayer had a reasonable belief that such
          value would be excludable from the employees’ gross income under § 911
          or Taxpayer was required by the law of a foreign country to withhold
          income taxes on such value.

FACTS

Taxpayer is a large American company that employs thousands of United States
citizens or residents in many countries around the world. Taxpayer’s employees
frequently transfer from country to country. Taxpayer maintains a “tax equalization”
policy in order to facilitate the transfers of its employees (“assignees”) to and from its
international affiliates. Tax equalization is a process that is intended to result in
assignees paying the same amount of income tax as the assignee would have paid if he
or she had not been stationed away from the country of citizenship on an international
assignment. Under the tax equalization process, Taxpayer calculates what is
commonly referred to as a “hypothetical tax.” The hypothetical tax calculation made
before the beginning of the tax year constitutes an approximation of what the assignee’s
overall tax liability would be for the upcoming year if that assignee were to remain in the
United States (“approximate hypothetical tax”). The assignee’s previously agreed upon
remuneration for the upcoming year is reduced by an amount equal to this approximate
hypothetical tax, and the assignee is not entitled to receive that portion of his or her
prior remuneration. Taxpayer will then pay all taxes owed by the assignee on
remuneration the assignee receives from Taxpayer, on behalf of the assignee, for both
the country where the assignee is stationed as well as the assignee’s country of
citizenship, without deducting such taxes from the assignee’s remuneration. Taxpayer’s
payment of the assignee’s taxes on the assignee’s behalf results in additional
remuneration to assignee. Taxpayer grosses up the additional remuneration that
results from Taxpayer paying the assignee’s taxes so that the assignee is not out of
pocket for any of the taxes paid on her or his remuneration from Taxpayer. Each
POSTN-135283-17 3

payment of tax on behalf of the employee creates additional income to the employee
and these additional amounts are also subject to tax.

At the end of the year, Taxpayer and the assignee calculate the exact amount of taxes
that the assignee would have owed had the assignee remained in the United States as
the “actual hypothetical tax.” Upon making the new calculation, Taxpayer and the
assignee adjust payments to make up the difference between the actual hypothetical
tax and the approximate hypothetical tax computed before the beginning of the year. If
the approximate hypothetical tax was too high, Taxpayer pays the assignee the
difference between the actual hypothetical tax amount and the approximate hypothetical
tax amount that reduced the previously agreed upon remuneration. If the approximate
hypothetical tax is too low, however, the assignee is required to repay a portion of the
assignee’s remuneration from Taxpayer. Thus, in order to adequately ascertain the
amount payable/receivable by Taxpayer to/from an assignee, the actual hypothetical tax
must be properly computed and compared to the approximate hypothetical tax. This
process, of reconciling the approximate and actual hypothetical tax calculations is
referred to as the “tax equalization settlement.”

In connection with its tax equalization policy, Taxpayer engaged CPA Firm to assist with
assignees’ tax matters. CPA Firm is a large, multinational accounting and consulting
firm. Taxpayer’s tax equalization policy provides that the following services will be
performed by CPA Firm with respect to tax-equalized assignees:

  (1)    Preparation of foreign, United States, and state tax returns;
  (2)    Computation and payment of the approximate and actual hypothetical tax
         and tax equalization settlements;
  (3)    Respond to inquiries from taxing authorities, as related to the foreign
         assignment;
  (4)    Global coordination of the assignment program; and
  (5)    Provide advice and instructions to Taxpayer’s payroll department
         regarding how to report and tax appropriately.

For federal employment tax purposes, Taxpayer valued the United States and state tax
return preparation services provided for the benefit of its assignees at $------per year,
and imputed this value as income and wages to its assignees. Taxpayer imputed no
income or wages to its assignees in connection with the value of the employer-provided
foreign tax return preparation services.

In valuing the United States and state tax return preparation services, Taxpayer relied,
in part, on:

  (1)    A --------survey conducted by the National Society of Accountants
         regarding the average tax preparation fees for an itemized Form 1040 with
         Schedule A and a state return; and

POSTN-135283-17 4

    (2)     A ------- Notice-----------------------, published by the United States Treasury
            Department (“Treasury Department Notice”), which estimated the average
            time burden and average cost of preparing a Form 1040, 1040A, or
            1040EZ return.

The National Society of Accountants survey and the Treasury Department Notice are
described in greater detail below.

In valuing the United States and state tax preparation services at $------per year for
federal employment tax purposes, Taxpayer additionally reasoned, in part, that, but for
the fact that Taxpayer sent the assignees on international assignment, the assignees
would only have required and obtained “basic” domestic federal (Form 1040 and
Schedule A) and state return preparation services. Moreover, Taxpayer determined
that any additional benefit provided to the assignees in connection with Taxpayer’s tax
equalization policy was primarily provided for Taxpayer’s benefit and, therefore, was
properly excludable from the assignees’ wages.

In connection with Taxpayer’s examination for the --------and --------taxable years, the
IRS requested (1) a complete list of all assignees who received tax preparation
services, and (2) a copy of Taxpayer’s tax preparation services contract with CPA Firm,
including fee structure, and all invoices related to CPA Firm’s services with respect to
Taxpayer’s tax equalization policy. Taxpayer provided the IRS with a list of employees
who received tax preparation services during the --------and --------taxable years, the
CPA Firm fee schedule, as well as a spreadsheet itemizing the invoice amounts for
each assignee.

The --------CPA Firm fee schedule indicated that $--------was actually paid by Taxpayer
for the preparation of each assignee’s United States income tax returns (federal and
one state). Of this total $--------charge, $------was attributable to non-tax preparation
(such as tax equalization and hypothetical tax calculations). Varying flat fees were also
paid by Taxpayer to the CPA Firm for foreign returns depending on the country (e.g., $--
----------for -------, $--------for ------, $------- for ---------, and $--------for ------). For ------, the
average tax preparation fee for a foreign return was $-------.

For ------, CPA Firm reduced its fee for preparation of the United States income tax
returns (federal and one state) to $--------per assignee. Of this total $--------charge, $----
------ was attributable to non-tax preparation (such as tax equalization and hypothetical
tax calculations). The average fee CPA Firm charged Taxpayer for a foreign return
preparation for --------was $-------, although the actual cost per foreign return, as
explained above, depended on the country of assignment.

The IRS proposed substantial adjustments with respect to FITW and FICA taxes for
Taxpayer’s --------and --------returns, based on the following assertions:
POSTN-135283-17 5

    (1)     The fair market value of the tax preparation services provided by Taxpayer
            under its tax equalization policy is includable in the assignees’ gross
            income for income tax purposes and constitutes wages for employment
            tax purposes.
    (2)     The fair market value of the tax preparation services is the amount that an
            individual would have to pay for such services in an arm’s length
            transaction, and the appropriate values of the tax preparation services as
            regards the assignees were at least equal to the amounts actually paid by
            Taxpayer to CPA Firm as reflected in the CPA Firm’s invoices.
    (3)     Taxpayer failed to reflect the proper value of the tax preparation services
            in the assignees’ wages, which resulted in wage underreporting and
            employment tax underpayment.

No adjustments were proposed by the IRS under the Federal Unemployment Tax Act
(FUTA) as the relevant wages (within the meaning of § 3306(b)) of all pertinent
employees exceeded the FUTA wage base limitation of § 3306(b)(1).

In making its adjustments with respect to FITW and FICA taxes, the IRS excluded from
assignees’ gross income and wages all costs attributable to Taxpayer’s tax equalization
calculations, and other costs not related to return preparation, from the valuation of the
tax preparation services.1 Thus, the IRS excluded all costs related to:

           Calculation of the hypothetical tax;
           Discussions with individuals about equalization issues, travel calendar,
            etc.;
           Tax payment coordination with Taxpayer for company balances due as
            part of the equalization arrangement; and
           Global coordination of the assignment program (meetings between
            Taxpayer and CPA Firm, status updates, reporting technology
            maintenance, etc.).

The IRS included in assignees’ gross income and wages costs related to tax
preparation, including:

           Preparation of basic domestic United States tax returns – 1040, 1040 NR,
            and first state return;
           Sourcing of compensation for Federal income tax purposes and the
            employee’s foreign tax credit;
           Sourcing of compensation for nonresident and part-year resident state
            income tax purposes;

1
The Service has previously concluded in FSA 200137039 that the value of services provided to the
employer for the specific purpose of calculating the amount owing by, or due to, the employer to equalize
the income tax costs of its employees working in other countries is excludable as a working condition
fringe benefit under section 132(d).
POSTN-135283-17 6

        Preparation of Form 1116 (Foreign Tax Credit) and Form 255 (Foreign
         Earned Income);
        Optimization of foreign earned income exclusion or foreign tax credit
         position;
        Coordination with foreign tax return preparer to confirm globally consistent
         approach to residency positions, treaty articles, etc.; and
        Notification to employees of foreign bank account reporting (FBAR)
         obligations if they had overseas financial accounts related to foreign
         assignment.

LAW

  Applicable Provisions of the Code and Regulations

         Gross Income

Section 61(a)(1) provides that, unless otherwise excluded, gross income means all
income from whatever source derived, including (but not limited to) compensation for
services, including fees, commissions, fringe benefits, and similar items. Section
1.61-1(a) further states that gross income includes income realized in any form, whether
in money, property, or services

Section 911(a) excludes from gross income, at the election of a qualified individual, the
foreign earned income of such individual and the housing cost amount of such
individual.

Section 911(d)(1) defines the term “qualified individual,” for purposes of § 911, as an
individual whose tax home is in a foreign country and who is either:

  (A)    a citizen of the United States who has been a bona fide resident of a
         foreign country for an uninterrupted period which includes an entire
         taxable year, or
  (B)    a citizen or resident of the United States and who, during any period of 12
         consecutive months, is present in a foreign country during at least 330 full
         days in such period.

Section 911(b)(1) defines the term “foreign earned income,” for purposes of § 911, as
the amount received by such individual from sources within a foreign country or
countries which constitute earned income attributable to services performed by such
individual during the time periods described in § 911(d).

Section 911(d)(2)(A), as relevant here, defines the term “earned income,” for purposes
of § 911, as wages, salaries, or professional fees, and other amounts received as
compensation for personal services actually rendered.
POSTN-135283-17 7

Section 911(d)(3) defines the term “tax home,” for purposes of § 911, with respect to
any individual, as such individual’s home for purposes of § 162(a)(2) (relating to
traveling expenses while away from home). Section 911(d)(3) further adds that an
individual shall not be treated as having a tax home in a foreign country for any period
for which his abode is within the United States.

Section 911(b)(2)(A) provides that the foreign earned income of an individual that may
be excluded under § 911(a) for any taxable year shall not exceed the amount of foreign
earned income computed on a daily basis at an annual rate equal to the exclusion
amount for the calendar year in which such taxable year begins. Section 911(b)(2)(D)(i)
states that, in general, the exclusion amount for any taxable year is $80,000. However,
under § 911(b)(2)(D)(ii), for years after 2005, such $80,000 amount is subject to cost-of-
living adjustments. For --------and ------, the exclusion amount under § 911(b)(2)(D) was
$----------and $---------, respectively.

         Excludable Fringe Benefits

Section 132(d) provides an exclusion from gross income for any fringe benefit that
qualifies as a “working condition fringe.” The term “working condition fringe” means any
property or services provided to an employee of the employer to the extent that, if the
employee paid for such property or services, such payment would be allowable as a
deduction under § 162 or § 167.

Section 1.132-5(a)(1)(iii) provides that an amount that would be deductible by the
employee under a section other than § 162 or § 167, such as § 212, is not a working
condition fringe.

Section 1.132-5(a)(2)(i) provides that if the hypothetical payment for a property or
service would be allowable as a deduction with respect to a trade or business of an
employee other than the employee’s trade or business of being an employee of the
employer, it cannot be taken into account for purposes of determining the amount, if
any, of the working condition fringe.

         Deductible Amounts

Section 162 provides that there shall be allowed as a deduction all the ordinary and
necessary expenses paid or incurred during the taxable year in carrying on any trade or
business.

Section 212(3) provides that, in the case of an individual, there shall be allowed as a
deduction all the ordinary and necessary expenses paid or incurred during the taxable
year in connection with the determination, collection, or refund of any tax.

Section 1.212-1(a)(1)(iii) provides that an ordinary and necessary expense paid or
incurred by a taxpayer in connection with the determination, collection, or refund of any
POSTN-135283-17 8

tax may be deducted under § 212. Section 1.212-1(l) further states that expenses paid
or incurred by an individual in connection with the determination, collection, or refund of
any tax, whether the taxing authority be federal, state, or municipal, and whether the tax
be income, estate, gift, property, or any other tax are deductible. The regulation adds
that, thus, expenses paid or incurred by a taxpayer for tax counsel or expenses paid or
incurred in connection with the preparation of his tax return or in connection with any
proceedings involved in determining the extent of tax liability or in contesting his tax
liability are deductible.

Courts have held that expenses paid or incurred by a taxpayer in connection with the
determination, collection, or refund of a foreign tax are deductible under § 212(3) in the
same manner as expenses paid or incurred in connection with the determination,
collection, or refund of a domestic tax. See, e.g., Sharples v. United States, 533 F.2d
550 (1976) (in which the court stated, in allowing a § 212(3) deduction in connection
with fighting a Venezuelan tax liability, that “the legislative history of subsection 212(3)
illustrates the breadth that Congress intended for this statute”).

          FICA Taxes

Sections 3101 (relating to the rate of tax on individuals), 3102(a) (relating to the
requirement to deduct the amount of the FICA tax from wages), and 3111 (relating to
the rate of tax on employers) collectively provide that every employer making payments
of wages is required to withhold and pay FICA taxes.

Section 3121(a) provides that, for FICA tax purposes, the term “wages” means all
remuneration for employment, including the cash value of all remuneration (including
benefits) paid in any medium other than cash, unless otherwise excepted.

Section 3121(a)(20) provides that, for FICA tax purposes, the term “wages” does not
include any benefit provided to or on behalf of an employee if at the time such benefit is
provided it is reasonable to believe the employee will be able to exclude such benefit
from income under § 132.

Section 3121(b) defines the term “employment,” in pertinent part, as including any
service, of whatever nature, by an employee for the person employing him, irrespective
of the citizenship or residence of either, within the United States; and service performed
outside the United States by a United States citizen or resident as an employee of an
American employer (as defined in § 3121(h)).

Section 3121(h) defines the term “American employer” as the United States or an
instrumentality thereof; a United States resident; a partnership, two-thirds or more of the
partners of which are United States residents; a trust, if all the trustees are United
States residents; and a corporation organized under the laws of the United States or of
any state.
POSTN-135283-17 9

The United States has established international social security agreements that
coordinate the United States Social Security program with the comparable programs of
other countries. These international social security agreements are generally referred
to as “totalization agreements.” A totalization agreement may affect the United States
FICA tax liability of a foreign national performing services in the United States, or of a
United States citizen or resident performing services outside the United States as an
employee of an American employer. See §§ 3101(c) and 3111(c).

          FITW

Section 3402(a)(1) generally requires every employer making payment of wages to
deduct and withhold upon such wages a tax determined in accordance with tables or
computational procedures prescribed by the Secretary.

Section 3401(a) generally defines the term “wages,” for purposes of § 3402, as all
remuneration for services performed by an employee for his employer, including the
cash value of all remuneration (including benefits) paid in any medium other than cash.

Section 3401(a)(19) provides that the term “wages” does not include any benefit
provided to or on behalf of an employee if at the time such benefit is provided it is
reasonable to believe the employee will be able to exclude such benefit from income
under § 132.

Section 3401(a)(8)(A)(i) excludes from the term “wages” remuneration for services for
an employer (other than the United States or any agency thereof) performed by a citizen
of the United States if, at the time of the payment of such remuneration, it is reasonable
to believe that such remuneration will be excluded from gross income under § 911.

Section 3401(a)(8)(A)(ii) excludes from the term “wages” remuneration for services for
an employer (other than the United States or any agency thereof) performed in a foreign
country or in a possession of the United States by a citizen of the United States if, at the
time of the payment of such remuneration, the employer is required by the law of any
foreign country or possession of the United States to withhold income tax upon such
remuneration.

Section 31.3401(a)(8)(A)-1(a)(1)(i) provides that the employer’s belief that § 911 applies
need only be based upon evidence reasonably sufficient to induce such belief, even
though the evidence is later determined by the Service or a court to be insufficient to
support an exclusion under § 911. However, the reasonable belief must be based upon
the application of § 911 and the regulations thereunder.

Section 31.3401(a)(8)(A)-1(b)(2) provides that remuneration is not exempt from
withholding if the employer is not required by the law of a foreign country or of a
possession of the United State to withhold income tax upon such remuneration. Mere
agreements between the employer and the employee whereby the estimated income
POSTN-135283-17 10

tax of a foreign country or of a possession of the United States is withheld from the
remuneration in anticipation of actual liability under the law of such country or
possession will not suffice.

   Other Applicable Guidance

In Rev. Rul. 73-13, 73-1 C.B. 42, the IRS ruled that the value of financial consulting
services provided by a company to its overseas employees is includible in gross income
under § 61 and constitutes wages for employment tax purposes.

In Rev. Rul. 92-29, 1992-1 C.B. 20, an individual taxpayer operating a consulting
business as a sole proprietorship paid a tax return preparer $500 to prepare his federal
income tax return. Of the $500, $200 was properly allocable to preparing Schedule C
(Profit or Loss from Business), and the remaining $300 was properly allocable to
preparing the remainder of the taxpayer’s federal income tax return, including Form
1040, Schedule A (Itemized Deductions), and Schedule B (Interest and Dividend
Income). Additionally, the taxpayer paid $800 for services rendered in resolving
asserted tax deficiencies relating to the business income of the taxpayer’s sole
proprietorship.

The IRS, in Rev. Rul. 92-29, concludes that in determining adjusted gross income under
§ 62(a)(1), the taxpayer may deduct expenses that relate to the taxpayer’s business as
a sole proprietor, including the $200 expense for preparing Schedule C and the $800
expense for resolving asserted tax deficiencies. The IRS also ruled that the taxpayer
may deduct the remaining $300 from adjusted gross income as an itemized deduction
under § 212(3) in determining taxable income, subject to the 2 percent floor limitation
under § 67.

Rev. Rul. 92-69, 1992-2 C.B. 51, analyzed whether employer-provided outplacement
services constituted gross income for income tax purposes, or wages for purposes of
FICA, FUTA, and FITW. In determining whether the value of employer-provided
outplacement services was excludable from gross income as a working condition fringe
in three different fact patterns, the IRS noted that § 1.132-5(a)(2)(i) requires that a
hypothetical payment for the services must be allowable as a deduction with respect to
the employee’s specific trade or business of being an employee of the employer, rather
than the employee’s general trade or business of performing services as an employee.
The Revenue Ruling states that this requirement is generally satisfied if, under all the
facts and circumstances, the employer derives a substantial business benefit from the
provision of the property or services that is distinct from the benefit that it would derive
from the mere payment of additional compensation, and the employee’s hypothetical
payment for the property or services would otherwise be allowable as a deduction by
the employee under § 162.
POSTN-135283-17 11

ANALYSIS

   Working Condition Fringe Analysis

The enactment of § 132, as part of the Deficit Reduction Act of 1984, P.L. 98-369,
effective January 1, 1985, resulted in the substitution of a statutory approach for the
prior common law approach in determining whether employer-provided fringe benefits
are excluded from gross income. The prior common law approach generally looked to
whether the fringe benefit was compensatory or non-compensatory. Consequently,
effective January 1, 1985, any fringe benefit is includable in the recipient’s gross income
unless the fringe benefit is excluded from gross income by a specific statutory provision.

The value of the tax preparation services provided by Taxpayer was a direct and
personal benefit to the assignees. Therefore, such value is includable in income unless
excluded by a specific statutory provision, such as § 132(d) which excludes working
condition fringes. In order for a benefit to be excludable as a working condition fringe,
the expense incurred in providing the benefit must be an expense that the employee
could deduct under section 162 if the employee had paid for the benefit herself or
himself. The tax preparation services in this case are not deductible by the employee
under section 162 because they are different from the business expenses of preparing a
Schedule C (Profit or Loss From Business), or resolving asserted tax deficiencies
relating to a taxpayer’s sole proprietorship described in Rev. Rul. 92-29. Like the
expenses associated with preparing a federal income tax return, including Form 1040,
Schedule A (Itemized Deductions) and Schedule B (Interest and Dividend Income) in
Rev. Rul. 92-29, the tax preparation services provided by Taxpayer to the assignees are
personal expenses of the assignees that would only be deductible by the assignees, if
at all, under § 212(3).

As stated in Rev. Rul. 92-69, in order for a fringe benefit to be excludable under
§ 132(d), as a working condition fringe, the employer must derive a substantial business
benefit from the provision of the property or services that is distinct from the benefit that
it would derive from the mere payment of additional compensation, and the employee’s
hypothetical payment for the property or services would otherwise be allowable as a
deduction by the employee under § 162. As provided in § 1.132-5(a)(1)(iii), an amount
that would be deductible by the employee under a section other than § 162, such as
§ 212, is not a working condition fringe.

The value of tax preparation services provided in this case cannot be deductible under
§ 162 because § 212(3) explicitly provides that all the ordinary and necessary expenses
paid or incurred during the taxable year in connection with the determination, collection,
or refund of any tax are deductible under that section (and thus not under § 162). See
Sharples, supra, at 555-556; Rev. Rul. 92-29. Unlike the outplacement services
described in Rev. Rul. 92-69, the value of the employer-provided tax preparation
services in this case cannot possibly qualify as a working condition fringe benefit under
§ 132(d) because the cost of such services are not allowable as a deduction by the
POSTN-135283-17 12

employees under § 162. See § 1.132-5(a)(1)(iii).2 Consequently, the value of
employer-provided tax preparation services in the present case cannot be excluded
from the assignees’ gross income under § 132(d) as a working condition fringe benefit.3

Similarly, as regards the foreign tax preparation services, since the assignees received
the same or similar personal benefit from having their foreign tax returns prepared as
they did from having their domestic returns prepared, and were personally obligated to
file complete and accurate tax returns, there is no valid basis for excluding the value of
the foreign tax preparation services from gross income while including the value of the
domestic tax preparation services. Expenses paid or incurred by a taxpayer in
connection with the determination, collection, or refund of a foreign tax are deductible
under § 212(3) in the same manner as expenses paid or incurred in connection with the
determination, collection, or refund of a domestic tax. See Sharples v. United States,
533 F.2d 550 (1976). Like the employer-provided financial consulting services
described in Rev. Rul. 73-13, the receipt of the Taxpayer-provided tax preparation
services (both for the domestic and foreign returns) conferred a direct and personal
benefit on the assignees, and the value received must be included in the assignees’
gross income under § 61.

In summary, the assignees in this case were obligated to file tax returns (both domestic
and foreign), and the tax preparation services provided to them by Taxpayer had a
direct bearing on their ability to fulfill this personal obligation. An employer paying a
personal expense of an employee results in taxable income to the employee. See Old
Trust Company v. Commissioner, 279 U.S. 716 (1929). Accordingly, based on the
foregoing, the value of the tax preparation services is includable in the assignees’
income.

The IRS correctly did not assert that the costs attributable to Taxpayer’s equalization
computations were includible in the assignees’ income and wages. These expenses
are correctly viewed as expenses of the employer and, unlike tax return preparation
costs, are not personal expenses of the assignee.

    The Value of the Tax Preparation Services

Section 1.61-21(b)(1) provides that an assignee must include in gross income the
amount by which the fair market value of the fringe benefit exceeds the sum of –

2
It has been the Service’s long-standing position that the fair market value of tax preparation services
provided by an employer to its employees in connection with the employer’s tax equalization policy is
includable in the employees’ gross income for income tax purposes and constitutes wages for
employment tax purposes. See TAM 8547003; NSAR 10795; and FSA 200137039.
3
We note also that it would not have been reasonable for the Taxpayer to believe that the tax preparation
services it provided to the assignees in this case were excludable as de minimis fringe benefits within the
meaning of section 132(e) because the value of the tax preparation services is not “so small as to make
accounting for it unreasonable or administratively impracticable.”
POSTN-135283-17 13

    (i)     The amount, if any, paid for the benefit by or on behalf of the recipient,
            and
    (ii)    The amount, if any, specifically excluded from gross income by some
            other section of the Code.

Section 1.61-21(b)(2) provides that, in general, fair market value is determined on the
basis of all the facts and circumstances. The regulation goes on to state that the fair
market value of a fringe benefit is the amount that an individual would have to pay for
the particular fringe benefit in an arm’s length transaction. The regulation further states
that an employee’s subjective perception of the value of a fringe benefit is not relevant
to the determination of the fringe benefit’s fair market value, nor is the cost incurred by
the employer determinative of the fair market value.

In computing the value of the United States income tax preparation services it provided
to assignees, Taxpayer relies, in part, on the average tax preparation fee for a return
according to a --------survey conducted by the National Society of Accountants.
According to that survey, the average tax preparation fees for an itemized Form 1040
with Schedule A and a state return in --------was $-----. Additionally, Taxpayer cites the -
-------Treasury Department Notice, which states that, using the best forward-looking
estimates available for income tax returns for tax year ------, the estimated average time
burden for all taxpayers filing a Form 1040, 1040A, or 1040EZ is ----hours, with an
average cost of $----- per return. The Notice explains that this average includes all
associated forms and schedules, across all preparation methods and taxpayer activities.
In a further breakdown of its estimates, the Notice adds that the average burden for
taxpayers filing Form 1040 is about ----hours and $-----; the average burden for
taxpayers filing Form 1040A is about ----hours and $-----; and the average for Form
1040EZ filers is about --hours and $---. Taxpayer concludes that its valuation of the
United States tax return preparation services, $-----, exceeds the value estimated by
both the National Society of Accounts and the Treasury Department Notice.

In contrast, the --------fee schedule of the CPA Firm utilized by Taxpayer indicates that
$--------was actually paid by Taxpayer for the preparation of each assignee’s United
States income tax returns (federal and one state), $------of which was attributable to
non-tax preparation (such as tax equalization and hypothetical tax calculations).
Varying fees were paid by Taxpayer to the CPA Firm for foreign returns depending on
the country (e.g., $--------for -------, $--------for ------, $--------for ---------, and $--------for ----
------). For ------, the average tax preparation fee for a foreign return was $-------.

For ------, CPA Firm reduced its fee for preparation of the U S income tax returns
(federal and one state) to $--------per assignee, $----- of which was attributable to non-
tax preparation (such as tax equalization and hypothetical tax calculations). The
average fee for a foreign return preparation for --------was $-------, although the actual
cost per foreign return, as explained above, depended on the country of assignment.
POSTN-135283-17 14

Neither the average tax preparation fee for an itemized Form 1040 with Schedule A and
a state return according to the --------survey conducted by the National Society of
Accountants, nor the Treasury Department Notice estimating the average time burden
and cost for all taxpayers filing a Form 1040, 1040A, or 1040EZ, represent an adequate
measure for determining the fair market value of the tax preparation services the
assignees in this case received. These assignees received sophisticated tax return
preparation services from a large, multinational accounting and consulting firm with
respect to both domestic and foreign tax returns. The fair market value of those
services is the amount that the same or a similar large, multinational accounting and
consulting firm would charge an individual employee for the same services in an arm’s
length transaction.

As noted above, the regulations specifically provide that neither the employee’s
subjective perception of the value of a fringe benefit nor the employer’s cost in providing
the benefit are determinative of its fair market value. Instead, the fair market value is
the amount that an individual would have to pay for the particular fringe benefit in an
arm’s-length transaction. Unfortunately, data regarding arm’s length transactions
between individual employees similar to the assignees and large, multinational
accounting and consulting firms similar to the CPA Firm for the same type of tax return
preparation services is not generally available. Large, multinational accounting and
consulting firms like the one utilized by Taxpayer in this case, which provide premier
international tax consulting services, do not typically have individual employees like the
assignees in this case as tax return preparation clients. Instead, large companies, like
Taxpayer, enter into contracts with multinational accounting and consulting firms, like
CPA Firm, to provide tax preparation services for numerous employees stationed in
various countries throughout the world.

In most cases, the employer’s cost in providing fringe benefits will be lower than the
amount an employee would have to pay for a particular benefit in an arm’s-length
transaction because the employer will have the benefit of discounts typically associated
with bulk purchasing and economies of scale. That may be particularly true in this case
in light of the fact that the tax preparation services were provided to numerous
assignees of Taxpayer stationed in many different countries.

We note that, although the employer’s cost is not, by itself, determinative of a benefit’s
fair market value, the facts and circumstances of this case indicate that it is reasonable
to use the amounts Taxpayer paid for the tax preparation services provided to the
assignees (i.e., the employer’s actual cost) as the best indicator of fair market value of
such services. First, it is not possible to determine what each assignee would have paid
if he or she engaged CPA Firm individually for the same services because CPA Firm
does not typically offer the same type of services to individuals like the assignees in this
case. Second, there is no survey data available to be used in determining the average
amounts charged for similar services by similar premier international tax consulting
firms. Finally, there is no reason to believe Taxpayer and CPA Firm did not engage in
an arm’s length transaction in arriving at a fair cost for the services. In this case, there
POSTN-135283-17 15

was an arm’s length transaction resulting in the precise amount charged for particular
services for specific individuals by a distinct service provider. Thus, the CPA Firm’s
charges paid by Taxpayer, in this case, is the most accurate information available to
determine the fair market value of the tax preparation services provided to the
assignees. If other credible information were available to establish that the fair market
value of the tax preparation services is either higher or lower than the charges to
Taxpayer, then the Service would be required to take such information into account.
However, in the absence of any other information, using the amounts actually paid by
Taxpayer to CPA Firm for the employer-provided tax preparation services under the
facts and circumstances of this case serves as a reasonable basis for determining the
fair market value of such services under § 1.61-21(b)(2).

   FICA Tax Analysis

For the reasons stated earlier, the value of the tax return preparation services provided
in-kind by Taxpayer to the assignees is not excludable as a working condition fringe
under § 132(d). Consequently, it was not reasonable for Taxpayer to believe at the time
the fringe benefit was provided that the employee receiving the benefit would be able to
exclude the benefit from gross income under section 132. Accordingly, the value of the
tax preparation services is not excepted from FICA taxes under § 3121(a)(20).
However, depending on the country of assignment and the length of the foreign
assignment, a totalization agreement between the United States and that country may
apply to determine the social security taxation of such employer-provided tax return
preparation services benefits.

   FITW Analysis

The value of the tax preparation services provided by Taxpayer to the assignees was
remuneration paid to the assignees in a medium other than cash. Therefore, pursuant
to § 3401(a), the value of the tax preparation services constitutes wages subject to
FITW, unless otherwise excepted. Moreover, for the reasons stated previously, it would
not have been reasonable for Taxpayer to believe, based on applicable law, that the
assignees were entitled to exclude the value of the tax preparation services from
income under § 132. Therefore, the value of the tax preparation services is not
excepted from income tax withholding under § 3401(a)(19).

Pursuant to § 3402(a)(8)(A)(i), the value of the tax return preparation services may be
excludable from wages for income tax withholding purposes if the Taxpayer had a
reasonable belief, at the time the services were provided, that the value of the services
would be excludable from the assignee’s gross income under § 911, provided the value
of the fringe benefit combined with all other remuneration paid to the employee for the
services performed was below the threshold. Provided the Taxpayer’s belief that § 911
applies is based upon the application of § 911 and the regulations thereunder,
Taxpayer’s belief need only be based upon evidence reasonably sufficient to induce
such belief, even though the evidence is later determined by the Service or a court to be
POSTN-135283-17 16

insufficient to support an exclusion under § 911. See § 31.3401(a)(8)(A)-1(a)(1)(i). It is
Taxpayer’s responsibility, in this case, to provide documentation to support exclusion of
wages from FITW under § 3402(a)(8)(A)(i).

Furthermore, Taxpayer in this case had assignees stationed in many different countries
throughout the world. Whether Taxpayer was required by the laws of any foreign
country to withhold income taxes on the value of the tax return preparation services it
provided to assignees depends upon the laws of each of the foreign countries in which
its assignees were stationed. If any of the laws of the foreign countries in which
assignees were stationed required Taxpayer to withhold income tax upon remuneration
paid to Taxpayer’s assignees, then § 3401(a)(8)(A)(ii) would apply to except the value
of the tax return preparation services provided to the assignees stationed in those
foreign countries from income tax withholding.

This writing may contain privileged information. Any unauthorized disclosure of this
writing may undermine our ability to protect the privileged information. If disclosure is
determined to be necessary, please contact this office for our views.

Please call (202) 317-4774 if you have any further questions.