Taxable vs. Nontaxable Fringe Benefits
Similar to how ordinary employee pay is reported, taxable fringe benefits are also reported.
Among the taxable fringe benefits include bonuses, company-provided automobiles, and group-term life insurance (with coverage exceeding $50,000).
Assistance with adoption, on-site food and recreational amenities, disability insurance, health insurance, and financial aid for school are all examples of nontaxable fringe benefits.
This article is for HR managers and small company owners who need to understand the distinction between taxable and nontaxable fringe benefits when designing an employee benefits package.
Offering excellent benefit packages to workers in addition to competitive pay may strengthen your hiring process and help you draw in and keep top talent. However, you should be aware of how each benefit is taxed before you increase your employee perks. Knowing what fringe benefits are and how they are taxed (or not taxed) may help you and your workers avoid unpleasant tax season surprises.
How do taxes and fringe benefits work?
The extra remuneration or benefit a business provides an employee on top of their normal income or earnings is known as a fringe benefit and is sometimes referred to as an employee benefit or perk. The majority of ancillary benefits are regarded by the IRS as taxable remuneration that has to be disclosed on tax forms, such as Form W-2, Wage and Tax Statement, and Form 1099-MISC, Miscellaneous Income.
As a result, they are taxed as normal income, according to Jorge De La Nuez, senior director of payroll, tax, and compliance at Namely, who spoke to Business News Daily. Fringe benefits that are deemed taxable are equivalent to taxable income. Taxes are taken out of your paycheck and reported on your yearly tax return when you get this kind of taxable fringe benefit from your employer.
What are taxable fringe benefits?
Employers are free to provide a wide range of appealing perks to their staff, but it’s crucial to understand which ones are tax-deductible (and hence need reporting) and which ones aren’t. An employee fringe benefit is likely to be taxed in some way, unless the Internal Revenue Code specifically states otherwise.
Since most fringe benefits are provided in the form of goods or services rather than cash payments, their cash-value equivalents are taxed at their fair market value.
According to Moses Balian, HR consulting manager at Justworks, “This equivalent value is taxed, exactly as how cash pay is taxable, except that the employee generally gets the benefit in the form of a product, service, or reimbursement.”
Some of the most common taxable fringe benefits, according to Balian, are:
- Discretionary bonuses (including gift cards)
- Income from exercise of nonstatutory stock options
- Taxable income from issuance or vesting of restricted stock
- Employer-provided cell phone (non-business use)
- Gym memberships
- Employer-provided vehicle or car lease
- Transportation benefits in excess of employer/employee pretax deferrals under a Section 132 Plan
- Housing allowance
- Moving expenses
- Meals and lodging (distinct from business travel)
- Reimbursement for classes or development unrelated to work (e.g., foreign language classes, if those classes are not work-related)
- Travel expenses not related to business (e.g., an extension to a business trip)
- Group-term life insurance (greater than $50,000 of coverage)
Some of these advantages could not be taxed depending on the situation. For instance, De La Nuez said that while extra fringe benefits like reimbursements are provided with post-tax revenues, they are not taxable at the time of distribution to the employee. This may include things like paying for internet access, tuition, and gym memberships.
It’s crucial to accurately track your tax and reporting duties when you provide your staff with a greater range of perks. Finding a payroll provider that can assist you in remaining compliant is advised by Balian.
According to Balian, “Your payroll platform has to be intelligent and easy to use enough to process and properly classify your fringe benefits in order to minimise tax errors and possible fines.”
What are nontaxable fringe benefits?
The majority of fringe benefits are taxed, although certain perks are excluded from this rule. Nontaxable fringe benefits are often exempt from reporting on W-2 forms and are typically not subject to federal income tax withholding, Social Security, Medicare, or federal unemployment tax (FUTA). However, since they might differ from case to case, it’s critical to understand the circumstances under which these benefits are regarded as nontaxable.
In accordance with De La Nuez, “Fringe benefits that are deemed nontaxable by the IRS are deducted on a pretax basis and [are] often disclosed on your yearly tax return.” Although some of the payments paid to these fringe benefits may be taxed upon withdrawal, they may still be deductible on a pretax basis.
The most common nontaxable fringe benefits include:
- Achievement awards (up to $1,600 for qualified plan awards)
- Adoption assistance
- Disability insurance (This includes employer-paid disability insurance premiums. Most benefits an employee receives under the policy are taxable)
- Dependent care assistance (up to $5,000 per year, as long as it doesn’t exceed the earned income of the employee or employee’s spouse)
- Educational assistance (up to $5,250 annually)
- Employee stock options (These may be subject to taxes)
- Group-term life insurance (Coverage shouldn’t exceed $50,000)
- Health savings accounts
- Medical insurance plans (e.g., health, dental and vision care)
- On-premises athletic facilities
- Lodging and meals (if offered on business premises or as a de minimis fringe benefit)
- Retirement planning services (Some benefits may be tax-deferred)
- Qualified employee discounts (up to certain limits. Employee discounts differ from subsidized memberships)
- Qualified transportation benefits, also known as commuter benefits (up to certain limits)
- No additional cost services
De minimis benefits are a cheap, nontaxable alternative for employers to use as a kind of fringe benefit. The IRS considers accounting for these benefits to be either inappropriate or administratively impossible because of their very low value.
According to De La Nuez, typical fringe perks that come under this heading include group meals, birthday or holiday presents (not cash), employer-provided local transportation, personal use of a corporate mobile phone, theatre or sports event tickets, and workplace snacks or beverages.
According to De La Nuez, offering these kinds of fringe benefits helps the company retain and recruit top employees without adding to its financial or administrative burdens.
Tips for determining taxable vs. nontaxable benefits
Employers need to be especially mindful of the nontaxable benefits they provide to their staff. According to Balian, a lot of expanding firms err when it comes to tuition reimbursement.
For instance, a nontaxable expense reimbursement can be used to pay for professional development related to work; however, tuition reimbursement for graduate and undergraduate courses is only tax-free up to $5,250 per year and only when it is made through a Section 127 Plan. This necessitates having a formal plan document that details who is eligible for financial aid for education, what is specifically covered, etc. Taxes apply to expenses that exceed $5,250. To learn more, see Should You Outsource HR?
These [plans] have stringent requirements, such as having a plan document, not being offered as an alternative to other forms of compensation, and not favouring highly compensated employees, according to Balian. Before providing employees with nontaxable tuition assistance reimbursement, “be sure to work with a reputable Section 127 Plan administrator.”
When putting up an employee benefits package, be sure to note each benefit’s “taxability” and make it plain in your employee handbook what you are providing. Working with a skilled benefits administrator to develop your benefits package is frequently beneficial.