Data breaches have become an unfortunate and unwelcome part of modern life, with stories about high profile hacks regularly leading the news. As businesses like Home Depot or health insurers like Anthem recently demonstrated, even the best efforts to keep customer or employee data secure can be infiltrated by cyber attack.
The federal Bureau of Justice Statistics reports that 17.6 million people fell victim to identity theft in 2014. Once a breach has occurred, companies will often provide some variety of protection service to customers or employees whose information may have been compromised. Whether it is credit reporting and monitoring, identify theft insurance policies or identity restoration services, their increased provision at no cost to the customer or employee began to raise questions of taxability. The IRS responded last summer to these previously unaddressed issues with the following guidance.
ID theft protection services are generally not taxable.
The IRS explained that the value of identity protection services provided by a business that experienced a breach to a customer or provided by an employer to an employee whose information may have been compromised in a breach does not create taxable income. It does not need to be reported on Form W-2 or 1099-Misc.
There are instances when ID theft protection services are taxable.
The IRS clarified that while the value of the identity protection service provided to compromised employees or customers is not taxable, cash given to employees or customers to purchase this service on their own is considered taxable. This expense must be included in gross income and reported on Form W-2 or 1099-Misc.
Furthermore, the IRS noted that this tax-exempt status applies only to identify theft protection services provided as a result of a data breach or hack. If this service is provided as a standard employee benefit or as part of an employee’s compensation package, it is considered taxable income. As a result, these costs must be included in gross income and reported on Form W-2 or 1099-Misc.
Contributed by Dennis R. Kelly, Jr., Senior Accountant in RKL’s Tax Services Group. Dennis provides tax services to a variety of clients and specializes in tax outsourcing and pass-through entity taxation. He works with clients in a variety of industries including construction and manufacturing and distribution.