Retired Pilot Taxed on Flights Employer Provided to Relatives

A fringe benefit is a perk provided to an employee. These benefits can make many forms. It may include a company car, company meals, or even insurance.

These benefits may or may not be taxable for the employee. The Mihalik v. Commissioner, T.C. Memo. 2022-36, case provides an opportunity to consider these rules.

The Mihalik case involves free stand-by flights. The flights were apparently provided to a retired employee’s adult children. The question is whether the retired employee, who is no longer performing services for the employer, has to pay taxes on a benefit provided by his former employer to his adult children.

This is just one of the many tax complications faxed by pilots.

Facts & Procedural History

The taxpayers are husband and wife. The husband worked as a pilot for United Airlines.

United Airlines had a Retiree Pass Travel Program. This program was a retirement benefit. It provided free stand-by air travel to retired pilots and their family members and friends.

United Airlines kept records that showed that the free travel for the taxpayers and their daughter were not taxable. The same records showed free travel provided to two additional parties. These parties had the same last name as the taxpayers, but were listed as “enrolled friends.” The United Airline records also noted that the flights to these parties were taxable.

The court notes that the record does not specify the relationship for the taxpayers and these two parties.

United Airlines issued a Form 1099 to the taxpayers to report the value of the flights provided to these two parties.

The taxpayers did not report the Form 1099 income on their tax return. The IRS issued a statutory notice of deficiency for this amount and litigation in the U.S. Tax Court ensued.

No Tax on No-Additional-Cost-Services

The taxpayers argued that the free travel were non-taxable fringe benefits.

Section 132 excludes from tax the value of certain fringe benefits provided by an employer to an employee. The tax court summarizes the rule as follows:

Gross income means all income from whatever source derived, unless specifically excluded by law. See § 61(a); Treas. Reg. § 1.61-1(a). Section 132 excludes from gross income the value of certain “fringe benefit[s]” provided by an employer to an employee. An employee must include in gross income the value of any fringe benefit provided to the employee, or to a third party on the employee’s behalf, that does not meet the criteria for exclusion under section 132. § 61(a)(1); see also Treas. Reg. § 1.61-21(a)(4).

This covers “no-additional-cost-services.” These are services provided by an employer to an employee at no substantial additional cost to the employer (including forgone revenue) for use by the employee, and offered for sale to customers in the ordinary course of business of the employer. 

The court agreed that stand-by flights like those are at issue here are generally “no-additional-cost-services” and not taxable. This is consistent with the examples in the regulations:

an employer-provided automobile, a flight on an employer-provided aircraft, an employer-provided free or discounted commercial airline flight, an employer-provided vacation, an employer-provided discount on property or services, an employer-provided membership in a country club or other social club, and an employer-provided ticket to an entertainment or sporting event.

But this tax-free status only applies if the benefit is provided to the taxpayers or their spouse or their dependent children.

Tax on Retired Employees and Others

Fringe benefits that do not meet the Sec. 132 exclusions, such as “no-additional-cost-services,” are generally taxable. They are taxable to the party who provided the services.

These rules are found in the regulations:

(i) In general. A taxable fringe benefit is included in the income of the person performing the services in connection with which the fringe benefit is furnished. Thus, a fringe benefit may be taxable to a person even though that person did not actually receive the fringe benefit. If a fringe benefit is furnished to someone other than the service provider such benefit is considered in this section as furnished to the service provider, and use by the other person is considered use by the service provider. For example, the provision of an automobile by an employer to an employee’s spouse in connection with the performance of services by the employee is taxable to the employee. The automobile is considered available to the employee and use by the employee’s spouse is considered use by the employee.

(ii) All persons to whom benefits are taxable referred to as employees. The person to whom a fringe benefit is taxable need not be an employee of the provider of the fringe benefit, but may be, for example, a partner, director, or an independent contractor. For convenience, the term “employee” includes any person performing services in connection with which a fringe benefit is furnished, unless otherwise specifically provided in this section.

They also apply to employees who are retired and no longer providing services. This language is found in Sec. 132(h):

With respect to a line of business of an employer, the term “employee” includes—
(A)any individual who was formerly employed by such employer in such line of business and who separated from service with such employer in such line of business by reason of retirement or disability, and
(B)any widow or widower of any individual who died while employed by such employer in such line of business or while an employee within the meaning of subparagraph (A).

These rules cast a wide net. They can pin the tax on just about anyone who performs services, even if the benefit is actually received by a third party as in the current case.

Who Qualifies as a Dependent Child?

For this exclusion, it is not all that clear whether the dependent child has to be a minor child.

Sec. 132 says that the term “dependent child” includes a child as defined in Section 152(f). Subsection (f) says that a child includes a son, daughter, stepson, or stepdaughter of the taxpayer, or an eligible foster child of the taxpayer.

Having satisfied the “child” requirement, one can then turn to Sec. 152 for a definition of the term dependent that runs throughout the tax code. Section 152 says that a “dependent” includes a qualifying child or a qualifying relative. The rules say that an individual can be a qualifying relative even if they are not a minor.

It would seem that, for purposes of the Sec. 132 fringe benefit rules, someone might be a “child” under Sec. 152(f) and a “dependent” as a qualifying relative even if they are not a minor. The wording of Sec. 132 seems to say this. Had Congress intended Sec. 132 to be limited to minor children, one would think that Congress would have cited the “qualifying child” language found in Sec. 152 in Sec. 132. It did not do so.

The argument may also be made that the free flights were gifts made by the employer to the adult children. For example, in this case, the court considered whether an employer made a gift to a former employee. Section 102 excludes gifts from income taxes.

It does not appear that the taxpayers raised this argument in this case. The court noted that the court record showed that the additional persons were over 30 years old at the time of the travel. The court reasoned that they could not have been the taxpayers’ minor children. Thus, the court decided the issue in the IRS’s favor on this basis.

The Takeaway

The fringe benefit exclusion and tax rules are complex. The rules are nuanced. A non-taxable fringe benefit for one taxpayers may be taxable for another. The results are not all that intuitive. As demonstrated by this case, this can even result in tax for a retired employee who did not receive a benefit from the fringe benefit provided to a third party. Taxpayers who receive fringe benefits have to be very careful about how they report the benefits.