Fringe Benefits: What's Taxable and What's Not

Posted by The Bean Team on 5/14/19 8:00 AM

Fringe Benefits_ What's Taxable and What's Not

4 MIN READ

When considering a job, most people know that you should look at more than just pay; you need to consider the entire benefits package offered. Fringe benefits—all those extra bells and whistles you receive from your employer on top of pay—can really make or break a job.

From an employer's standpoint, a competitive benefits package can help attract and retain top talent. But deciding which fringe benefits to offer is no easy task, especially because when it comes to taxes, not all fringe benefits are treated equally. Depending on the benefit offered, it may be classified as either taxable or nontaxable. 

But before we dig into that distinction, let's first define what a fringe benefit is.

A fringe benefit is simply a form of pay other than money for an employee’s work performance, or “performance of services.” Just like pay, some—but not all—fringe benefits are subject to withholding and employment taxes and must therefore be included as income on an employee’s W-2. Other fringe benefits are tax-free and need not be included in the employee’s compensation.

As a small business owner, it’s entirely up to you to decide what, if any, fringe benefits you will offer your employees. When making this decision, it’s important to understand which fringe benefits are taxable and which are not to avoid any surprises when tax time rolls around.

Taxable Fringe Benefits

Nearly all fringe benefits are taxable. Taxable fringe benefits are included in gross income and subject to federal income tax, Social Security tax, Medicare tax, and FUTA.

Examples of taxable fringe benefits include:

  • Bonuses
  • Value of personal use of employer provided vehicle
  • Group life insurance in excess of $50,000
  • Vacation expenses
  • Relocation expenses
    NOTE: The Tax Cuts and Jobs Act made the reimbursement of expenses for employee moves of more than 50 miles taxable for 2018 through 2025.
  • Amounts paid to employees for relocation in excess of actual expenses
  • Gym membership
    NOTE: The IRS usually sees this as a taxable fringe benefit if paid by the employer on behalf of the employee. This benefit would therefore need to be included in an employee’s gross wages. There is a caveat though; if you provide an on-site gym facility, the fair market value of the membership does not need to be included in the individual employee’s gross wages and the employer can take a deduction for the gym expenses.

When claiming these fringe benefits, employers and employees must claim the “fair market value” of the benefit. "Fair market value" simply means the amount someone would pay if they acquired the benefit on their own. The fair market value amount may differ from the actual amount paid by an employer because companies often receive corporate discounts.

Taxable fringe benefits paid by an employer are typically subject to withholding when they are made available to the employee. An employer can choose to treat taxable fringe benefits as paid on a schedule of their choosing—per pay period, quarterly, semi-annually, or annually—but all benefits must be considered paid no later than December 31 of the calendar year in which they were provided.

Taxable fringe benefits must be reported on Form W-2 (Form 1099-MISC for independent contractors and Schedule K-1 for partners). The employee must claim the fair market value of all taxable fringe benefits on their annual personal income tax return. 

Nontaxable Fringe Benefits

There are certain benefits you can provide as an employer that are exempt from taxation. These are called nontaxable fringe benefits, and are not subject to federal income tax withholding, are excluded from gross income, and are not reported on Form W-2.

Some examples of nontaxable fringe benefits include:

  • Accident and health benefits (S-Corp shareholders are exempt from receiving this benefit tax-free)
  • Achievement awards (exempt up to $1,600 for qualified plan awards and $400 for non-qualified awards; S-Corp shareholders are exempt from receiving this benefit tax-free)
  • Group life insurance up to $50,000
  • Dependent care assistance – exempt up to certain limits, $5,000 ($2,500 for married employee filing separate return)
    • This exclusion applies to household and dependent care services you directly or indirectly pay for or provide to an employee under a written dependent care assistance program that covers your employees.
  • Educational assistance – exempt up to $5,250 of benefits each year
    • There must be a written plan that provides educational assistance only to your employees. The program qualifies only if all of the following tests are met:
      • It benefits employees who qualify under rules set up by the employer that don’t favor highly compensated employees.
      • The program doesn’t provide more than 5% of its benefits during the year for shareholders or owners (or their spouses or dependents). A shareholder or owner is someone who owns (on any day of the year) more than 5% of the stock or of the capital or profit interest of business.
      • The program doesn’t allow employees to choose to receive cash or other benefits.
      • Reasonable notice of the program is given.
    • Employee discounts
    • Employee stock options
    • Health savings accounts (HSAs) – exempt for qualified individuals up to the HSA contribution limits
    • Retirement planning services
      • You may exclude from an employee’s wages the value of any retirement planning advice or information you provide to the employee if you maintain a qualified retirement plan.
    • Transportation (commuting) benefits – exempt up to certain limits if for rides in a commuter highway vehicle and/or transit passes ($265) or qualified parking ($265). You may provide an employee with one or all of these benefits at the same time.

Fringe Benefits for S-Corps Shareholders

There’s another factor to consider when distinguishing taxable and nontaxable fringe benefits: employee status. S-Corp shareholders, for example, do not always receive tax-free fringe benefits. Why? Because a 2% or greater shareholder is not treated as an employee; rather, they are treated as a partner in a partnership for fringe benefit purposes.

Above, we distinguished that S-Corp shareholders are exempt from receiving health benefits tax-free. This is because the self-employed health insurance deduction allows self-employed individuals to deduct the cost of health insurance against income. You can’t get a pre-tax benefit from the company and then also take that same benefit as a deduction on your individual tax return. Instead, health insurance is included in gross income and can be deducted on your tax return. 

This blog is meant to provide a cursory overview of fringe benefits. Employers should reference the IRS Publication 15-B, Employer’s Tax Guide to Fringe Benefits, for a comprehensive breakdown of the federal tax laws regarding fringe benefits.

Click here to contact the Bean Team! 

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