It’s a topic that has been in the news lately. Exactly what constitutes taxable fringe benefits for employees?Which are perfectly legal perks, and which are to be avoided?
First of all, what’s the definition of a fringe benefit? Sometimes referred to as an employee benefit or perk, it’s a form of payment, which includes property, services, cash, or cash equivalent, in addition to payment for the performance of services (salary). Under the Internal Revenue Code, all income is taxable unless an exclusion applies. Some examples of excludable fringe benefits are health insurance, certain travel expenses, and certain educational assistance.1
For example, it’s a fringe benefit if you let an employee drive a business vehicle to commute to and from work. But please note—this person who performs services for you doesn't have to be your employee; they can work as an independent contractor. 2
In addition, a benefit may fall under the jurisdiction of more than one Internal Revenue Code section. For example, under Code Section 127, education expenses up to $5,250 may be excluded from tax. Under Code Section 132, education expenses exceeding $5,250 may be excluded. Even if someone other than the employee, such as a spouse or a child receives the benefit, the employee must be taxed for the benefit their employer provides on an employee’s behalf. 3
Generally, fringe benefits are included in an employee’s gross income, although there are some exceptions. These benefits are subject to income tax withholding and employment taxes. Fringe benefits include:
- Cars and flights on aircraft that the employer provides;
- Free or discounted commercial flights;
- Vacations;
- Discounts on property or services;
- Memberships in country clubs or other social clubs; and
- Tickets to entertainment or sporting events. 4
Taxable fringe benefits include bonuses, company-provided vehicles, and group term life insurance (if coverage exceeds $50,000). 5
The IRS views most fringe benefits as taxable compensation; employees would report them exactly as they would their standard taxable wages, displayed in Form W-2 or Form 1099-MISC. 6
If a benefit is taxable, the employer must report it on Form W-2 as wages, and by and large, it’s subject to federal income tax withholding, Social Security, and Medicare taxes. But let’s say the employee's wages aren't normally subject to Social Security or Medicare taxes. Let’s say the employee is covered by a qualifying public retirement system. Then these taxes wouldn’t apply to any fringe benefits the employee received.7
For example, bonuses are always taxable, because they’re classified as income under Code Section 6. As I mentioned before, all income is taxable, unless an exclusion applies. For instance, because qualified health plan benefits are excludable under Code Section 105, they’re not listed on form W-2 in wages. 8
How are taxable fringe benefits valued? They’re included in wages at their fair market value. If the employer's cost to provide a benefit is less than the value to the employee, you should reduce a benefit’s taxable amount by any amount paid by or for the employee.9
What are nontaxable fringe benefits? They can include adoption assistance, on-premises meals and athletic facilities, disability insurance, health insurance, and educational assistance. In most instances, nontaxable fringe benefits are excluded from federal income tax withholding, Social Security, Medicare or federal unemployment tax (FUTA). Often there’s no need to report them on a W-2 form. But you must be aware of the conditions under which these benefits are deemed nontaxable, since they can vary on a case-by-case basis.10
This brings us to another topic—the subject of taxable fringe benefits is very complex, and sometimes special circumstances apply that wouldn’t occur to a layman. For that reason, I’d recommend consulting IRS guidelines, as well as a very proficient CPA who’d well-versed in this field, to avoid potential pitfalls. The IRS offers this very helpful webinar, in addition to this webpage, and this article is a good source for its detailed lists of taxable and nontaxable fringe benefits.
References
- https://www.irsvideos.gov/Webinars/TaxableFringeBenefitsForEmployers
- https://www.irsvideos.gov/Webinars/TaxableFringeBenefitsForEmployers
- https://www.irsvideos.gov/Webinars/TaxableFringeBenefitsForEmployers
- https://www.irs.gov/businesses/small-businesses-self-employed/employee-benefits
- https://www.businessnewsdaily.com/16006-taxable-vs-nontaxable-fringe-benefits.html
- https://www.businessnewsdaily.com/16006-taxable-vs-nontaxable-fringe-benefits.html
- https://www.irsvideos.gov/Webinars/TaxableFringeBenefitsForEmployers
- https://www.irsvideos.gov/Webinars/TaxableFringeBenefitsForEmployers
- https://www.irsvideos.gov/Webinars/TaxableFringeBenefitsForEmployers
- https://www.businessnewsdaily.com/16006-taxable-vs-nontaxable-fringe-benefits.html
