A retired airline pilot attempted to dispute the IRS’s position that he had to pay tax on the value of airline tickets on his former employer’s flights used by relatives other than his spouse in the case of Mihalik v. Commissioner, TC Memo 2022-36.[1]

Although many individuals believe that items that aren’t cash received for services aren’t taxable, that’s not what the Internal Revenue Code says. In fact, IRC section 61(a)(1) provides specifically that fringe benefits are generally taxable to the employee when received.

(a) General definition. Except as otherwise provided in this subtitle, gross income means all income from whatever source derived, including (but not limited to) the following items:

(1) Compensation for services, including fees, commissions, fringe benefits, and similar items;[2]

So why are some fringe benefits not taxable to employees? The answer is that other provisions of the Internal Revenue Code provide limited exceptions to the general rule that fringe benefits are taxable to the employee. But those exceptions are narrow and have requirements that must be met or the value of the benefit will be taxable to the employee

Standby Flights and the No-Additional Cost Service Exclusion

This case involves the no additional cost service fringe benefit exclusion made available to certain employees of employers who have such no additional cost services available to provide to their employees. Section 132(a)(1) of the Internal Revenue Code provides that such items will not be included in the gross income of the employee.

Internal Revenue Code section 132(b) provides the definition of a no additional cost service.

(b) No-additional-cost service defined. For purposes of this section, the term “no-additional-cost service” means any service provided by an employer to an employee for use by such employee if—

(1) such service is offered for sale to customers in the ordinary course of the line of business of the employer in which the employee is performing services, and

(2) the employer incurs no substantial additional cost (including forgone revenue) in providing such service to the employee (determined without regard to any amount paid by the employee for such service).[3]

In the case of an airline, the no additional cost service represents otherwise empty seats on a flight that is otherwise scheduled to be flown by the airline. Since that seat is going to travel from one location to another whether or not a person is sitting in the seat, the airline is allowed to offer the use of that empty seat to its employees and certain relatives as we will discuss next if no paying customer is available to take the seat.

The court even points out in a footnote that such seats cannot be reserved for the employee, because that would make it no longer a no additional cost service:

If a commercial airline permits its employees to take personal flights on the airline at no charge and to receive reserved seating, employees receiving such free flights are not eligible for the no-additional-cost service exclusion. Treas. Reg. § 1.132-2(c). In such instances the airline forgoes potential revenue by permitting the employees to reserve seats, and therefore the service is not a no-additional-cost service. Id.[4]

IRC section 132(h) provides special definitions of “employees” for this purpose that expand those eligible for tax free use of the seats beyond just the employee him/herself. First, a retired employee, along with disabled employees and surviving spouses of employees, are treated as employees for this purpose under IRC section 132(h)(1).

(1) Retired and disabled employees and surviving spouse of employee treated as employee. 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).[5]

IRC section 132(h)(2) expands this definition of an employee to also cover spouses and dependent children of the employee or the retired employee. Thus, these relatives of the taxpayer in this case would qualify for the exclusion as well.

(2) Spouses and dependent children.

(A) In general. Any use by the spouse or a dependent child of the employee shall be treated as use by the employee.

(B) Dependent child. For purposes of subparagraph (A), the term "dependent child" means any child (as defined in section 152(f)(1)) of the employee --

(i) who is a dependent of the employee, or

(ii) both of whose parents are deceased and who has not attained age 25.

For purposes of the preceding sentence, any child to whom section 152(e) applies shall be treated as the dependent of both parents.[6]

Although not relevant for the current case, you should also note that parents of airline employees also qualify for this exclusion under a special rule found at section 132(h)(3).

De Minimis Fringe Benefits

Another category of excludable fringe benefits found in the Internal Revenue Code at section 132(a)(4) are de minimis fringe benefits.

IRC section 132(e)(1) defines such a benefit as follows:

(e) De minimis fringe defined. For purposes of this section—

(1) In general. The term “de minimis fringe” means any property or service the value of which is (after taking into account the frequency with which similar fringes are provided by the employer to the employer’s employees) so small as to make accounting for it unreasonable or administratively impracticable.[7]

The Facts of the Case

Mr. Mihalik and his family made use of this benefit from his former employer. As the court notes:

Mr. Mihalik, Mrs. Mihalik, and their daughter traveled extensively under the RPTP in 2016. United Airlines’ records list Mrs. Mihalik’s relationship to Mr. Mihalik as “Spouse” and the Mihaliks’ daughter’s status as “Daughter”. The records also report a zero taxable “wage amount” for tickets issued to Mr. Mihalik, Mrs. Mihalik, and their daughter, and add the note “no taxation” behind each of those entries. The taxable nature of the tickets issued to each of them is not in dispute.

Because of their connection to Mr. Mihalik, Sean Garth Mihalik and Jessica Marie Liening Mihalik also received tickets from United Airlines under the RPTP in 2016. United Airlines’ records list Sean’s and Jessica’s relationships to Mr. Mihalik as “Enrolled Friend”, label each as a “taxable pass rider”, and report a taxable “wage amount” for each ticket issued to Sean and Jessica under the RPTP. Because Sean and Jessica have the same surname as the Mihaliks, we assume that they also share some familial relation. But the Mihaliks do not offer any information to clarify that relation and therefore, for the purposes of the Commissioner’s motion, we assume that Sean and Jessica are simply relatives (to an unknown degree) of the Mihaliks. Although some dates are redacted, the records list the birth years for Sean and Jessica as 1983 and 1984, meaning Sean and Jessica were both over the age of 30 in 2016.[8]

Mr. Mihalik’s former employer (United Airlines) reported the value of Sean and Jessica’s flights on Form 1099-MISC:

The value of the tickets provided to Sean and Jessica under Mr. Mihalik’s RPTP in 2016 equaled $5,478.3 United Airlines reported this amount as income paid to Mr. Mihalik on the Form 1099–MISC, “Miscellaneous Income”, which it filed with the IRS.[9]

On their joint return for 2016, the Mihaliks did not include the value of Sean and Jessica’s flights as income. The IRS is now pursuing collection of tax on the value of those flights.

Nonqualifying Relatives Create Taxable Income

The taxpayers appeared to argue before the court that the amounts shown on the 1099-MISC for the value of Sean and Jessica’s flights should not be taxable to them either because of the no additional cost service exclusion or because the benefit represented a de minimis fringe benefit.

The opinion agrees with the IRS that the value of tickets used by Sean and Jessica are taxable to the taxpayers because neither of those individuals could be the taxpayers’ dependent children.

Although we view factual inferences in the light most favorable to the Mihaliks and therefore assume Sean and Jessica were relatives of the Mihaliks because of their shared surname, United Airlines’ records and the Mihaliks’ 2016 return support the conclusion that neither Sean nor Jessica was the Mihaliks’ dependent child in 2016. Neither Sean nor Jessica was under the age of 19 in 2016, and therefore, no matter what their relationship is to the Mihaliks, they cannot qualify as “dependents” under section 152(c) (or, necessarily, as “dependent children” under section 132(h)).

To prevail against the Commissioner’s motion, the Mihaliks must show that Sean and Jessica qualified as their dependent children under section 132(h) in 2016. But the Mihaliks do not dispute the Commissioner’s showing that Sean and Jessica were not their dependent children in 2016, that Sean and Jessica received tickets from United Airlines under the RPTP, or that the tickets had the value calculated by United Airlines.[10]

Some of you might be thinking that the full-time student rule might have applied, but the court noted in a footnote:

The Mihaliks do not allege that Sean and Jessica were full-time students in 2016, so the age 24 threshold of section 152(c)(3)(A)(ii) is inapplicable.[11]

The court also did not find the value of the flights taken by Sean and Jessica represented an excludable de minimis fringe benefit under IRC section 132(a)(4). The opinion notes the taxpayers provided no evidence to support the view that the tickets represented a de minimis benefit under the law, but there was a more crucial problem regardless of the evidence they might have attempted to bring forward noted by the Court:

…[A]ny argument that the airline tickets constitute a de minimis fringe benefit would manifestly fail on its merits. United Airlines’ records indicate that it issued airline tickets frequently under the RPTP and the value of the airline tickets issued to Sean and Jessica ($5,478) greatly exceeds the low-fair-market-value examples provided by Treasury Regulation § 1.132-6(e). It is also clearly neither unreasonable nor administratively impracticable for United Airlines to account for tickets issued under the RPTP. To the contrary, United Airlines records document substantial data about the RPTP tickets, including the tax implications to Mr. Mihalik of the tickets provided to non-family members.[12]

Most likely the taxpayers were operating under the misconception discussed at the beginning of this article. Since the value of the tickets used by their relatives were not paid out by the airline in cash to the taxpayers, the taxpayers believed that such items could not be taxable to them. Unfortunately, that’s not the way the underlying law works, something it appears from reading the case that the taxpayers never really grasped.

As the court noted in the opinion the taxpayers never really address the requirements to show why they met any exception from inclusion of the value of these flights in their income. They seemed to be working from the assumption that these noncash benefits would just simply not be taxable to them.

[1] Mihalik v. Commissioner, TC Memo 2022-36, April 13, 2022, https://www.taxnotes.com/research/federal/court-documents/court-opinions-and-orders/plane-ticket-values-not-excludable-from-retired-pilot%e2%80%99s-income/7dcwk (retrieved April 20, 2022)

[2] IRC §61(a)(1)

[3] IRC §132(b)

[4] Mihalik v. Commissioner, TC Memo 2022-36, April 13, 2022

[5] IRC §132(h)(1)

[6] IRC §132(h)(2)

[7] IRC §132(e)(1)

[8] Mihalik v. Commissioner, TC Memo 2022-36, April 13, 2022

[9] Mihalik v. Commissioner, TC Memo 2022-36, April 13, 2022

[10] Mihalik v. Commissioner, TC Memo 2022-36, April 13, 2022

[11] Mihalik v. Commissioner, TC Memo 2022-36, April 13, 2022

[12] Mihalik v. Commissioner, TC Memo 2022-36, April 13, 2022