Perks. Extras. Allowances. Whatever you like to call them, fringe benefits are an added way to attract and retain quality employees. They’re also a form of pay for the performance of services—which means they’re taxable unless specifically excluded by law.
To help you stay compliant with tax laws, here’s a rundown on the basics of fringe benefits and their taxation.
What qualifies as fringe benefits?
Fringe benefits can come in many forms. You have the more traditional varieties, including:
- Health and life insurance
- Tuition assistance
- Childcare reimbursement
- Company vehicles or transportation passes
There are also smaller benefits that might seem like nothing more than a simple spiff or reward. But they are indeed considered fringe benefits. Achievement awards, employee discounts and free meals are a few examples.
You must also consider third-party fringe benefits. These are benefits provided by a third party to a company’s employees in exchange for the services of the employer. For example, an accounting firm performs bookkeeping services for a car detailing service. In exchange, the detailer cleans the employees’ cars once a month. This would be a fringe benefit for the employee.
It’s important to note that employees aren’t the only ones who can receive fringe benefits from a company. Independent contractors, directors, and partners are also eligible.
Must a business withhold payroll taxes on all of these?
Not necessarily. Many fringe benefits have rules that partially or completely exclude their value from the recipient’s pay.
Some fringe benefits are excludable simply because they’re small. These are often called de minimis (minimal) benefits. They include meals provided to employees, working condition benefits (such as using a company car for business), retirement planning services and other no-additional-cost services.
More commonly, however, fringe benefits are exempt based on certain requirements. For some, this means that specific conditions must be met. These include:
- Accident and health benefits
- Athletic facility use
- Employer-provided cell phones
- Health savings accounts (HSAs)
- Meals and lodging on business premises
- Tuition reduction
Other fringe benefits have exemptions based on stated monetary limitations. In other words, there’s a dollar amount at which use of these benefits is capped. Achievement awards, dependent care assistance, education assistance, employee discounts and transportation benefits are just a few examples.
Still other fringe benefits are only subject to certain specific taxes. Group life insurance, for example, is exempt up to $50,000 of coverage and then only subject to Social Security and Medicare taxes. Accident or health plans are also excludable from employee wages except for long-term care benefits provided through a flexible spending arrangement (FSA). Employer-provided adoption assistance is exempt from federal income taxes but subject to Social Security, Medicare and unemployment (FUTA) taxes.
What about stock options?
Some employee stock options are indeed taxable. Disbursements from incentive stock options and employee stock purchase plan options aren’t included in employee wages when exercised by employees. That isn’t the case for non-statutory (nonqualified) stock options, which must be reported on the employee’s W-2 when exercised. Know the difference if you don’t want to create an unnecessary tax burden for your employees.
How can an employer help reduce this tax burden?
In most cases, employers would like to offer benefits that are typically taxable. One solution is to provide what’s called a cafeteria plan. This allows employees to choose from a variety of benefits and pay for them out of their gross income. By doing so, they receive qualified benefits (that would normally be taxed) on a pre-tax basis.
Generally, cafeteria plans allow employees to choose between cash and taxable fringe benefits, but choosing the taxable fringe benefit will not make the benefit taxable to employees under the cafeteria plan.
When should businesses evaluate whether their fringe benefits are taxable?
Valuation of taxable fringe benefits must be determined no later than January 31 of the following year. Before then, employers can reasonably estimate the value of fringe benefits in order to make timely withholding and deposits.
That said, there’s never a bad time to see how the tax impact of your benefits package can be improved. James Moore’s manufacturing CPAs can review your company’s fringe benefits to make sure they satisfy exemption requirements. You can also work with our HR Consulting team to help choose the best benefits for your employees and organization.
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