Proposed Regulations Govern Employee Prizes and Awards.

ACTION: Notice of proposed rulemaking.

SUMMARY: This document contains proposed amendments to the regulations relating to the excludability of certain prizes and awards and to the deductibility of certain employee awards. Changes to the applicable tax law were made by the Tax Reform Act of 1986. These amendments, if adopted, will provide the public with the guidance needed to comply with this Act.

DATES: Written comments and requests for a public hearing must be delivered or mailed by March 10, 1989. The amendments are proposed to be effective after December 31, 1986.

ADDRESS: Send comments and requests for a public hearing to: Commissioner of Internal Revenue, Internal Revenue Service, 1111 Constitution Avenue, N.W., Washington, D.C. 20224; Attention: CC:CORP:T:R, IA-111-86.

FOR FURTHER INFORMATION CONTACT: Johnnel St. Germain of the Office of Assistant Chief Counsel (Income Tax and Accounting), Internal Revenue Service, 1111 Constitution Avenue, N.W., Washington, D.C. 20224; Attention: CC:CORP:T:R, IA-111-86. Telephone 202-566-4509 (not a toll-free call).

SUPPLEMENTARY INFORMATION:

PAPERWORK REDUCTION ACT

The collections of information contained in this notice of proposed rulemaking have been submitted to the Office of Management and Budget for review in accordance with the Paperwork Reduction Act of 1980 (44 U.S.C. 3504(h)). Comments on the collections of information should be sent to the Office of Information and Regulatory Affairs, Office of Management and Budget, Washington, D.C. 20503, attention: Desk Officer for the Internal Revenue Service. Copies of comments should also be sent to the Internal Revenue Service at the address previously specified.

The collections of information in this regulation are in 26 CFR sections 1.74-1(c). This information is required by the Internal Revenue Service in order to verify that the proper amount of income is reported by taxpayers on their returns of tax. The likely respondents are individuals.

Estimated total annual reporting burden: 1,275 hours.

Estimated average annual burden per respondent: 15 minutes.

Estimated number of respondents: 5,100.

BACKGROUND

This document contains proposed amendments to the Income Tax Regulations (26 CFR Part 1) under sections 74, 102, and 274 of the Internal Revenue Code (Code). The amendments are proposed to conform the regulations to section 122 of the Tax Reform Act of 1986 (Pub. L. 99-514). The proposed amendments, if adopted, will be issued under the authority contained in section 7805 of the Code (68A Stat. 917; 26 U.S.C. 7805).

GENERAL INFORMATION

Prior to the 1986 Code, section 74 stated that prizes and awards, other than certain types of fellowship grants and scholarships, were includible in gross income unless they were made primarily in recognition of religious, charitable, scientific, educational, artistic, literary, or civic achievement. To qualify for the exclusion, the recipient must have been selected without any action on his part and could not be required to render substantial services as a condition to receiving the prize or award.

Within the context of a business relationship, prizes and awards that would otherwise be includible in a recipient's gross income were excludable if they qualified as gifts under section 102. In general, section 274(b) disallowed an employer a business deduction for gifts to an employee to the extent that the total cost of all gifts of cash, tangible personal property, and other items to the same individual during the taxable year exceeded $25. A special exception to the $25 limitation was allowed for items of tangible personal property awarded to an employee for length of service, safety achievement, or productivity. The employer could deduct the cost of such an award up to $400. If the item was provided under a qualified award plan, the deductibility limitation was increased to $1600, provided the average cost of all plan awards made during the year did not exceed $400. A de minimis fringe benefit under section 132(e) was, and continues to be, excludable from gross income and is not subject to the requirements imposed upon prizes and awards under sections 74 and 274.

EXPLANATION OF PROVISIONS

These proposed amendments relate to the excludability of certain prizes and awards and to the deductibility of certain employee awards and reflect the substantial changes made by the Tax Reform Act of 1986 (the Act) to sections 74, 102 and 274 of the Internal Revenue Code (Code). Changes to the applicable sections of the Code and regulations, amended or newly incorporated by this document, are effective for awards made after December 31, 1986.

Under the Act, the section 74(b) exclusion for prizes or awards received in recognition of charitable achievement is available only if the payor transfers the prize or award to one or more entities described in paragraph (1) and/or (2) of section 170(c), pursuant to the direction of the recipient.

Section 1.74-1(c) of the proposed regulations requires that recipients of prizes end awards clearly designate, in writing, within 45 days of the date the item is granted that they wish to have the prize or award transferred to one or more qualifying donee organizations. The proposed regulations set forth requirements which, in certain instances, determine whether a qualifying designation has been made.

Section 1.74-1(d) of the proposed regulations clarifies that the exclusion under section 74(b) will not be available unless the prize or award is transferred by the payor to one or more qualified donee organizations before the recipient, or any person other than the grantor or a qualified donee organization, uses the item. In general, a transfer may be accomplished by any method that results in receipt of the prize or award by, or on behalf of, one or more qualified donee organizations.

Section 1.74-1(e) further clarifies the requirements of section 74(b) by defining certain terms. Definitions are included which determine what constitutes a "qualified donee organization," when a "disqualifying use" has taken place, and when an item is considered "granted."

Section 1.74-1(f) provides that neither the payor nor the recipient of the prize or award may claim a charitable contribution deduction for the value of any prize or award for which an exclusion is allowed under section 74(b).

All of the requirements of section 74(b) in existence prior to passage of the Act remain in effect end must be met in order for the award recipient to be eligible for the exclusion. Accordingly, rules and regulations governing these additional requirements, to the extent they are not inconsistent with the proposed regulations, will remain in effect.

New Code section 74(c) excludes certain employee achievement awards from gross income. The exclusion applies, subject to certain limitations, to the value of awards made by the employer for safety achievement or length of service achievement. The amount of the exclusion generally corresponds with the deduction given the employer under new section 274(j) for these "employee achievement awards." Thus, in general, the employee must include these awards in income to the extent that the fair market value of the award, or, if greater, the cost of the award to the employer, exceeds the amount deductible under section 274(j). The exclusion allows an employee to exclude the full fair market value of the award where the cost of the award is fully deductible by the employer.

Section 1.74-2(d) of the proposed regulations provides special rules for employee achievement awards applicable to sole-proprietors and tax-exempt employers.

Section 1.74-2(e) clarifies that an employee award, whether or not an employee achievement award, may be excludible from gross income as a de minimis fringe benefit under section 132(e).

Section 102(c) of the Code clarifies that, with the exception of employee achievement awards under section 74(c) and de minimis fringe benefits under section 132(e), an employee shall not exclude from gross income any amount transferred to the employee (or for the employee's benefit) by, or on behalf of, the employer in the form of a gift, bequest, devise, or inheritance. Therefore, while awards satisfying the requirements of section 74(c) and de minimis fringe benefits qualifying under section 132(e) will be excluded from gross income under those sections, no amounts (except in certain narrowly defined circumstances) transferred by, or on behalf of, an individual's employer will be excludable from gross income under section 102.

Section 1.102-1(f)(2) of the proposed regulations provides that for purposes of section 102(c), extraordinary transfers to the natural objects of one's bounty will not be considered transfers for the benefit of an employee if it can be shown that the transfer was not made in recognition of the transferee's employment. Thus, the rules set out in Comm. v. Duberstein, 363 U.S. 278 (1960), formerly applicable in the determination of whether all property transferred inter-vivos from an employer to an employee constitutes a gift, will only be applicable where the transferee employee would be the natural object of the employer's bounty.

From an employer's perspective, the Act substantially modifies an employer's ability to deduct the cost of certain employee awards. New section 274(j) defines deductible "employee achievement awards" to include only those awards made for length of service achievement or safety achievement. In addition, an employee achievement award must be an item of tangible personal property awarded as part of a meaningful presentation and made under conditions and circumstances that do not create a significant likelihood of the payment of disguised compensation.

Section 274(j) also establishes a limit on the amount that may be deducted by an employer. The annual deduction limitation per employee is $400 for employee achievement awards that are not awarded as part of a qualified award plan. The annual deduction limitation per employee is $1,600 for employee achievement awards that are awarded as part of a qualified award plan. In no event may an employer deduct more than $1,600 per employee for all employee achievement awards made during the year. An award is not a qualified plan award where the average cost of all employee achievement awards made by the employer pursuant to a plan exceeds $400 during the taxable year.

Section 1.274-8(b) of the proposed regulations clarifies that the $1,600 deduction limitation applies in the aggregate, so that the $1,600 limitation for qualified plan awards and the $400 limitation for employee achievement awards that are not qualified plan awards cannot be added together to allow deductions exceeding $1,600 for employee achievement awards made to an employee in a taxable year.

Section 1.274-8(c)(2) of the proposed regulations provides that tangible personal property does not include cash or any gift certificate other than a nonnegotiable gift certificate conferring only the right to receive tangible personal property. The proposed regulations also give examples of what will be considered to create a significant likelihood of the payment of disguised compensation. For example, the providing of employee achievement awards in a manner that discriminates in favor of highly paid employees will be considered to be payment of disguised compensation.

Section 1.274-8(c)(5) of the proposed regulations defines a "qualified plan award" as an employee achievement award presented pursuant to an established written award plan or program of the employer that does not discriminate as to eligibility or benefits.

Section 1.274-8(d)(1) of the proposed regulations states that the deduction limitations shall apply to a partnership as well as to each member of the partnership. Paragraph (d)(2) provides that the cost of length of service achievement awards (other than awards excludable under section 132(e)) may only be deducted by the employer if the employee has at least 5 years of service with the employer and has not received a length of service achievement award during that year or any of the 4 prior years. In addition, this paragraph clarifies that although a retirement award will be treated as having been provided for length of service achievement, it may also qualify for treatment as a de minimis fringe benefit under section 132(e) of the Code. Paragraph (d)(3) provides guidance with respect to safety achievement awards. An employer may deduct the cost of safety achievement awards only when presented to no more than 10% of an employer's eligible employees. Eligible employees include any employee who has worked for the employer in a full time capacity for at least one year and who is not a manager, administrator, clerical employee, or other professional employee. Special rules clarify that in the case where more than 10% of an employer's eligible employees receive a safety achievement award, no award will be considered to be awarded for safety achievement if it cannot be determined that that award was presented before the 10% limitation was exceeded.

The Act specifically excludes awards qualifying as de minimis fringe benefits under section 132(e) from the requirements for length of service achievement and safety achievement. As a result, employers are not required to consider section 132(e) awards in determining whether employee achievement awards comply with the 5 year limitations for length of service achievement and the 10% eligible employee limitations for safety achievement.

SPECIAL ANALYSES

The Commissioner of Internal Revenue has determined that this proposed rule is not a major rule as defined in Executive Order 12291. Accordingly, a Regulatory Impact Analysis is not required. The Internal Revenue Service has concluded that although this document is a notice of proposed rulemaking that solicits public comment, the regulations proposed herein are interpretative and the notice and public procedure requirements of 5 U.S.C. 553 do not apply. Accordingly, no Regulatory Flexibility Analysis is required for this rule.

COMMENTS AND REQUESTS FOR A PUBLIC HEARING

Before adopting these proposed regulations, consideration will be given to any written comments that are submitted (preferably eight copies) to the Commissioner of Internal Revenue. All comments will be available for public inspection and copying. A public hearing will be held upon written request to the Commissioner by any person who has submitted written comments. If a public hearing is held, notice of time and place will be published in the Federal Register.

DRAFTING INFORMATION

The principal author of these proposed regulations is Christopher J. Wilson, formerly of the Legislation and Regulations Division of the Office of Chief Counsel, Internal Revenue Service. However, personnel from other offices of the Internal Revenue Service and Treasury Department participated in developing the regulations, on matters of both substance and style.

LIST OF SUBJECTS IN 26 CFR 1.61-1 THROUGH 1.281-4

Income taxes, Taxable income, Deductions, Exemptions.

PROPOSED AMENDMENTS TO THE REGULATIONS

The proposed amendments to 26 CFR Part 1 are as follows:

Part 1 [Amended]

SECTION 1.74-1 [Amended]

Paragraph 1. The authority for Part 1 continues to read in part:

Authority: 26 U.S.C. 7805. * * *

Par. 2. Section 1.74-1 is amended as follows:

      (a) Paragraph (a)(1) is amended by

(b) EXCLUSION FROM GROSS INCOME . . . award; and (4) the payor transfers the prize or award (and the prize or award is, in fact, transferred) to one or more governmental units or organizations described in paragraph (1) or (2) of section 170(c) pursuant to a designation by the recipient. Accordingly, awards such as the Nobel prize and the Pulitzer prize will qualify for the exclusion if the award is transferred by the payor to one or more qualifying organizations pursuant to a qualified designation by the recipient.

(c) DESIGNATION BY RECIPIENT -- (1) IN GENERAL. To qualify for the exclusion under this section, the recipient must make a qualifying designation, in writing, within 45 days of the date the prize or award is granted (see paragraph (e)(3) of this section for a definition of "granted"). A qualifying designation is required to indicate only that a designation is being made. The document does not need to state on its face that the organization(s) are entities described in paragraph (1) and/or (2) of section 170(c) to result in a qualified designation. Furthermore, it is not necessary that the document do more than identify a class of entities from which the payor may select a recipient. However, designation of a specific nonqualified donee organization or designation of a class of recipients that may include nonqualified donee organizations is not a qualified designation. The following example illustrates the application of this section:

A distinguished opthalmologist, S, is awarded the Nobel prize for medicine. S may designate that the prize money be given to a particular university that is described in section 170(c)(1), or to any university that is described in that section. However, S cannot designate that the award be given to a donee that is not described in section 170(c)(1), such as a foreign medical school. Selection of such a donee or inclusion of such a donee on a list of possible donees on S's designation would disqualify the designation.

(2) PRIZES AND AWARDS GRANTED BEFORE 60 DAYS AFTER DATE OF PUBLICATION OF FINAL REGULATIONS. In the case of prizes and awards granted before 60 days after date of publication of final regulations, a qualifying designation may be made at any time prior to 105 days after date of publication of final regulations.

(d) TRANSFERRED BY PAYOR. An exclusion will not be available under this section unless the designated items or amounts are transferred by the payor to one or more qualified donee organizations. The provisions of this paragraph shall not be satisfied unless the items or amounts are transferred by the payor to one or more qualifying donee organizations no later than the due date of the return (without regard to extensions) for the taxable year in which the items or amounts would otherwise by includible in the recipient's gross income. A transfer may be accomplished by any method that results in the receipt of the items or amounts by one or more qualified donee organizations from the payor and does not involve a disqualifying use of the items or amounts. Delivery of items or amounts by a person associated with a payor (e.g., a contractual agent, licensee, or other representative of the payor) will satisfy the requirements of this section so long as the items or amounts are received by, or on behalf of, one or more qualified donee organizations. Possession of a prize or an award by any person before a designation is made will not result in the disallowance of an exclusion unless a disqualifying use of the items or amounts is made before the items or amounts are returned to the payor for transfer to one or more qualified donee organizations (see paragraph (e)(2) of this section for a definition of "disqualifying use"). Accordingly, transfer of an item or amount to a nonqualified donee organization will not result in an ineffective transfer under this section if the item or amount is timely returned to the payor by the nonqualified donee organization before a disqualifying use of the item or amount is made and the item or amount is that transferred t a qualifying organization.

(e) DEFINITIONS -- (1) For purposes of this section, "qualified donee organizations" means entities defined in section 170(c)(1) or (2) of the Code.

(2) For purposes of this section, the term "disqualifying use" means, in the case of cash or other intangibles, spending, depositing, investing or otherwise using the prize or award so as to enure to the benefit of the recipient or any person other than the grantor or an entity described in section 170(c)(1) or (2). In the case of tangible items, the term "disqualifying use" means physical possession of the item for more than a brief period of time by any person other than the grantor or an entity described in section 170(c)(1) or (2). Thus, physical possession by the recipient or a person associated with the recipient may constitute a disqualifying use if the item is kept for more than a brief period of time. For example, receipt of an unexpected tangible award at a ceremony that otherwise comports with the requirements of this section will not constitute a disqualifying use unless the recipient fails to return the item to the payor as soon as practicable after receipt.

(3) For purposes of this section, an item will be considered "granted" when it is subject to the recipient's dominion and control to such an extent that it otherwise could be includible in the recipient's gross income.

(f) CHARITABLE DEDUCTION NOT ALLOWABLE. Neither the payor nor the recipient will be allowed a charitable deduction for the value of any prize or award that is excluded under this section.

(g) QUALIFIED SCHOLARSHIPS. See section 117 and the regulations thereunder for provisions relating to qualified scholarships.

Par. 3. New section 1.74-2 is added to immediately follow section 1.74-1 as set forth below.

SECTION 1.74-2 SPECIAL EXCLUSION FOR CERTAIN EMPLOYEE ACHIEVEMENT AWARDS.

(a) GENERAL RULE -- (1) Section 74 (c) provides an exclusion from gross income for the value of an employee achievement award (as defined in section 274 (j)) received by an employee if the cost to the employer of the award does not exceed the amount allowable as a deduction to the employer for the cost of the award. Thus, where the cost to the employer of an employee achievement award is fully deductible after considering the limitation under section 274 (j), the value representing the employer's cost of the award is excludable from the employee's gross income.

(2) Where the cost of an award to the employer is so disproportionate to the fair market value of the award that there is a significant likelihood that the award was given as disguised compensation, no portion of the award will qualify as an employee achievement award excludable under the provisions of this section (see also section 1.274-8(c)(1) and (4)).

(b) EXCESS DEDUCTION AWARD. Where the cost to the employer of an employee achievement award exceeds the amount allowable as a deduction to the employer, the recipient must include in gross income an amount which is the greater of (1) the excess of such cost over the amount that is allowable as a deduction (but not to exceed the fair market value of the award) or (2) the excess of the fair market value of the award over the amount allowable as a deduction to the employer.

(c) EXAMPLES. The operation of this section may be illustrated by the following examples:

(2) In the case of an employer exempt from taxation under Subtitle A of the Code, any reference in this section to the amount allowable as a deduction to the employer shall be treated as a reference to the amount which would be allowable as a deduction to the employer if the employer were not exempt from taxation under Subtitle A of the Code.

(e) EXCLUSION FOR CERTAIN DE MINIMIS FRINGE BENEFITS. Nothing contained in this section shall preclude the exclusion of the value of an employee award that is otherwise qualified for exclusion under section 132 (e).

Par. 4. Section 1.102-1 is amended as follows:

      (a) The last sentence of paragraph (a) is removed.

* * * * *

(f) EXCLUSIONS -- (1) IN GENERAL. Section 102 does not apply to prizes and awards (including employee achievement awards) (see section 74); certain de minimis fringe benefits (see section 132); any amount transferred by or for an employer to, or for the benefit of, an employee (see section 102(c)); or to qualified scholarships (see section 117).

(2) EMPLOYER/EMPLOYEE TRANSFERS. For purposes of section 102(c), extraordinary transfers to the natural objects of an employer's bounty will not be considered transfers to, or for the benefit of, an employee if the employee can show that the transfer was not made in recognition of the employee's employment. Accordingly, section 102(c) shall not apply to amounts transferred between related parties (e.g., father and son) if the purpose of the transfer can be substantially attributed to the familial relationship of the parties and not to the circumstances of their employment.

SECTION 1.274-1 [AMENDED]

Par. 5. Section 1.274-1 is amended by removing everything after the word "business" in the last sentence of paragraph (d) and adding in its place "activity, see section 1.274-6."; revising paragraph (e) and adding paragraph (f) to read as follows:

* * * (e) treatment of personal portion of entertainment facility, see section 1.274-7, and (f) employee achievement awards, see section 1.274-8.

SECTION 1.274-3 [AMENDED]

Par. 6. Section 1.274-3 is amended as follows:

(a) The last sentence of paragraph (b)(1) is amended by substituting "subsections (b) and (c) of section 74" for "section 74(b)".

(b) The language "recipient, or" at the end of paragraph (b)(2)(ii) is replaced by the language "recipient."

(c) Subdivisions (iii) and (iv) of paragraph (b)(2) are removed.

(d) The first, second, and fourth sentences of the flush material immediately following subdivision (iv) are removed and the last sentence is amended by substituting "sections 61, 74, 102, and 132" for "sections 61, 74, and 102".

(e) Paragraph (d) is removed and paragraphs (e), (f), and (g) are redesignated as paragraphs (d), (e), and (f).

Par. 7. Section 1.274-8 is redesignated as section 1.274-9 and a new section 1.274-8 is added immediately following section 1.274-7 to read as set forth below.

SECTION 1.274-8 DISALLOWANCE OF CERTAIN EMPLOYEE ACHIEVEMENT AWARD EXPENSES.

(a) IN GENERAL. No deduction is allowable under section 162 or 212 for any portion of the cost of an employee achievement award (as defined in section 274(j)(3)(A)) in excess of the deduction limitations of section 274(j)(2).

(b) DEDUCTION LIMITATIONS. The deduction for the cost of an employee achievement award made by an employer to an employee: (1) which is not a qualified plan award, when added to the cost to the employer for all other employee achievement awards made to such employee during the taxable year which arm not qualified plan awards, shall not exceed $400, and (2) which is a qualified plan award, when added to the cost to the employer for all other employee achievement awards made to such employee during the taxable year (including employee achievement awards which are not qualified plan awards), shall not exceed $1,600. Thus, the $1,600 limitation is the maximum amount that may be deducted by an employer for all employee achievement awards granted to any one employee during the taxable year.

(c) DEFINITIONS -- (1) EMPLOYEE ACHIEVEMENT AWARD. The term "employee achievement award", for purposes of this section, means an item of tangible personal property that is transferred to an employee by reason of the employee's length of service or safety achievement. The item must be awarded as part of a meaningful presentation, and under conditions and circumstances that do not create a significant likelihood of the payment of disguised compensation. For purposes of section 274 (j), an award made by a sole proprietorship to the sole proprietor is not an award made to an employee.

(2) TANGIBLE PERSONAL PROPERTY. For purposes of this section, the term "tangible personal property" does not include cash or a certificate (other than a nonnegotiable certificate conferring only the right to receive tangible personal property). If a certificate entitles an employee to receive a reduction of the balance due on his account with the issuer of the certificate, the certificate is a negotiable certificate and is not tangible personal property for purposes of this section. Other items that will not be considered to be items of tangible personal property include vacations, meals, lodging, tickets to theater and sporting events and stocks, bonds, and other securities.

(3) MEANINGFUL PRESENTATION. Whether an award is presented as part of a meaningful presentation is determined by a facts and circumstances test. While the presentation need not be elaborate, it must be a ceremonious observance emphasizing the recipient's achievement in the area of safety or length of service.

(4) DISGUISED COMPENSATION. An award will be considered disguised compensation if the conditions and circumstances surrounding the award create a significant likelihood that it is payment of compensation. Examples include the making of employee achievement awards at the time of annual salary adjustments or as a substitute for a prior program of awarding cash bonuses, the providing of employee achievement awards in a manner that discriminates in favor of highly paid employees, or, with respect to awards the cost of which would otherwise be fully deductible by the employer under the deduction limitations of section 274(j)(2), the making of an employee achievement award the cost of which to the employer is grossly disproportionate to the fair market value of the item.

(5) QUALIFIED PLAN AWARDS -- (i) IN GENERAL. Except as provided in paragraph (c)(5)(ii) of this section, the term "qualified plan award" means an employee achievement award that is presented pursuant to an established written plan or program that does not discriminate in terms of eligibility or benefits in favor of highly compensated employees. See section 414(q) of the Code for the definition of highly compensated employees. Whether an award plan is established shall be determined from all the facts and circumstances of the particular case, including the frequency and timing of any changes to the plan. Whether or not an award plan is discriminatory shall be determined from all the facts and circumstances of the particular case. An award plan may fail to qualify because it is discriminatory in its actual operation even though the written provisions of the award plan are nondiscriminatory.

(ii) ITEMS NOT TREATED AS QUALIFIED PLAN AWARDS. No award presented by an employer during the taxable year will be considered a qualified plan award if the average cost of all employee achievement awards presented during the taxable year by the taxpayer under any plan described in paragraph (c)(5) i) of this section exceeds $400. The average cost of employee achievement awards shall be computed by dividing (A) the sum of the costs to the employer for all employee achievement awards (without regard to the deductibility of those costs) by (B) the total number of employee achievement awards presented. For purposes of the preceding sentence, employee achievement awards of nominal value shall not be taken into account in the computation of average cost. An employee achievement award that costs the employer $50 or less shall be considered to be an employee achievement award of nominal value.

(d) SPECIAL RULES -- (1) PARTNERSHIPS. Where employee achievement awards are made by a partnership, the deduction limitations of section 274(j)(2) shall apply to the partnership as well as to each member thereof.

(2) LENGTH OF SERVICE AWARD. An item shall not be treated as having been provided for length of service achievement if the item is presented for less than 5 years employment with the taxpayer or if the award recipient received a length of service achievement award (other than an award excludable under section 132(e)(1)) during that year or any of the prior 4 calendar years. An award presented upon the occasion of a recipient's retirement is a length of service award subject to the rules of this section. However, under appropriate circumstances, a traditional retirement award will be treated as a de minimis fringe. For example, assume that an employer provides a gold watch to each employee who completes 25 years of service with the employer. The value of the gold watch is excluded from gross income as a de minimis fringe. However, if the employer provides a gold watch to an employee who has not completed lengthy service with the employer or on an occasion other than retirement, the value of the watch is not excludable from gross income under section 132(e).

(3) SAFETY ACHIEVEMENT AWARDS -- (i) IN GENERAL. An item shall not be treated as having been provided for safety achievement if --

(A) During the taxable year, employee achievement awards (other than awards excludable under section 132(e)(1)) for safety achievement have previously been awarded by the taxpayer to more than 10 percent of the eligible employees of the taxpayer, or

(B) Such item is awarded to a manager, administrator, clerical employee, or other professional employee.

(ii) "ELIGIBLE EMPLOYEE" DEFINED. An eligible employee is one not described in paragraph (d)(3)(i)(B) of this section and who has worked in a full-time capacity for the taxpayer for a minimum of one year immediately preceding the date on which the safety achievement award is presented.

(iii) SPECIAL RULES. Where safety achievement awards are presented to more than 10 percent of the taxpayer's eligible employees, only those awards presented to eligible employees before 10 percent of the taxpayer's eligible employees are exceeded shall be treated as having been provided for safety achievement. Where the only safety achievement awards presented by an employer consist of items that are presented at one time during the calendar year, then, if safety achievement awards are presented to more than 10 percent of the taxpayer's eligible employees, the taxpayer may deduct an amount equal to the product of the cost of the item (subject to the applicable deduction limitation) and 10 percent of the taxpayer's eligible employees. Except as provided in the preceding sentence, no award shall be treated as having been provided for safety achievement except to the extent that it can be reasonably demonstrated that that award was made before the 10 percent limitation was exceeded.