Employee discounts on services and products are a popular fringe benefit in the veterinary industry. After all, veterinarians want all animals to receive the care they need, and since most team members have pets, the discounts are highly utilized, though the markdown can vary widely from practice to practice. Employee discounts, however, can lead to tax implications. So how did such a simple and generous concept become so fraught?
Let’s start with the IRS. I know the Internal Revenue Service is the last thing you want to think or read about, so I’ve done the work for you. The upshot: You can offer any discount you like, even $15,000 worth of free services to every employee. The IRS doesn’t care. (By the way, I care as a practice consultant, so don’t do it!) What the IRS does care about, though, is receiving tax dollars on that free or discounted care.
At a certain level, employee discounts become taxable income to the staff. To stay off the IRS radar, you may offer up to a 20% discount on veterinary services and charge essentially your cost plus 10% on products. Those discounts are between you and the staff.
However, go beyond those discounts and the difference is taxable income to the employee and subject to payroll tax and income tax withholding. Taxable discounts are reported through payroll and appear on an individual’s W2. (Verify that your payroll company can adequately account for taxable fringe benefits. Some can’t.)
I know what you’re thinking.
- “Other practices give bigger employee discounts.”
- “If we work on employees’ pets when we’re not busy, why does the IRS care?”
- “The staff won’t like what you’re saying at all.”
Let’s address each.
The Size of the Discount
Remember, you can give as large a discount as you like. How it’s reported, not the size, is the key. The IRS tax ruling isn’t new, but generous discounts are more likely to be sniffed out than in the past. The U.S. government is always looking for money, so unreported employee discounts are an easy target.
The Cost to the Practice
If business is slow, does treating employee pets for free really matter to the IRS? Yes. First, the IRS counts any lost revenue as a cost. The time spent on staff pets is time you aren’t seeing paying clients. Even if no clients are scheduled, they theoretically could be seen, and the theoretical fees you would have charged are considered a cost. A pet care benefit provided at “significant cost” is — you guessed it — taxable to the employee, according to the IRS.
To make matters worse, if the doctors and staff spend “substantial time” treating employee pets, the IRS automatically determines that the business incurred substantial costs, even if the time spent would otherwise be idle and even if the services occurred outside regular business hours. Ugh, there goes the plan to bring in your dog on a Saturday evening.
The Staff’s Reaction
Ah, this is the biggest issue. Too often, team members are so accustomed to discounted or free care that they see it as an entitlement. Instead, make the IRS the bad guy.
If you need to revise your discount policy, explain the changes at a staff meeting. Make everyone aware of the potential repercussions for the practice and employees if the IRS were to audit your hospital’s records. The IRS can charge back taxes and penalties on unreported discounts over the past three years, sometimes longer. No one wants that.
Therefore, make employee discounts easy to track and report. Set up two codes in your practice management software: one for discounts on services and the other for discounts on products. If you ever need to demonstrate that you follow IRS guidelines, those two reports will be easy to produce. Such a system also helps to notify your payroll processor.
The next step is to make sure employees see the cumulative total of discounted pet care they receive. The taxable benefits should be shown monthly or every pay period. Regular reporting also makes any additional payroll taxes less burdensome to employees.
Several colleagues advise “grossing up” employee pay to cover additional payroll taxes. In other words, if a staff member received $250 worth of services at no charge, $200 is considered taxable income ($250 less a 20% discount). While the practice owes payroll taxes on the $200, the employee is responsible for payroll and income taxes, so my colleagues suggest increasing the team member’s gross earnings by the amount owed.
Should the practice owner eat the $250 and another 8% for the employee portion of payroll taxes and even more for employee income taxes? Some hospitals will, but I don’t advise it. If an employee complains about paying $20 to $30 for something costing a client $250 or more, the team member needs some perspective.
Regarding products, staff members can receive discounted food directly from vendors, preventive medication for one or two pets annually, and reduced or free lab tests when the sample is identified as coming from a staff pet. Employees can buy products for pennies over cost, and their pets receive discounted medical care.
Let’s contrast that with what an employee at a human hospital may receive. Human hospitals don’t provide employees with no-cost services for themselves and their families. For example, ear, nose and throat doctors don’t invite staff members to bring in their kids for free tonsillectomies on slow days. Instead, those employees pay whatever their health insurance doesn’t cover.
So, then, is pet health insurance a good employee benefit? The advantages include:
- The ability to use the insurance at another veterinary hospital, including at emergency and specialty centers.
- Staff members receive firsthand experience with pet insurance and can explain it better to clients.
The disadvantage is that most pet insurance policies exclude pre-existing conditions. Also, pet insurance is a taxable benefit. So even though the practice pays the premiums, the employees pay the income taxes.
BAH! HUMBUG!
The IRS requires businesses to report the value of taxable fringe benefits at least annually, but reporting employee discounts throughout the year is better. If you wait until year-end and withhold all the related taxes in one pay period, employees in holiday-spending mode should prepare for a smaller paycheck.