Taxable vs Nontaxable Fringe Benefits

As a small business owner, you know how important it is to attract and retain the right people. One of the ways you do that is by offering fringe benefits. Fringe benefits are a form of compensation given to workers for performance of services in addition to their usual salary or wages. They can range from big benefits, like health insurance and retirement plan matching, to little perks like free snacks and drinks in the break room.

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Some employers (and their employees) consider fringe benefits to be free perks of the job, but that isn’t always the case. Many fringe benefits are taxable to the employee and subject to withholding and employment taxes. However, there are some exceptions.

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So let’s look at some common tax-free and taxable fringe benefits to make things easier at tax time.

What Are Taxable Fringe Benefits?

You may pay taxable fringe benefits to full-time or part-time employees, independent contractors, or owners or shareholders of the business. They’re considered part of the recipient’s taxable income and subject to federal (and possibly state) income tax withholding, Social Security, and Medicare (FICA) taxes.

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According to IRS Publication 15-B, Employer’s Tax Guide to Fringe Benefits, “any fringe benefit you provide is taxable and must be included in the recipient’s pay unless the law specifically excludes it.”

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Some common taxable fringe benefits include:

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• Bonuses
• Gym memberships
• Personal use of a business vehicle
• Group term life insurance coverage greater than $50,000
• Vacation expenses
• Job-related moving expense reimbursements beyond the employee’s actual expenses

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So why does this matter? Well, if you provide taxable fringe benefits to employees and don’t include them in the employee’s gross pay or withhold the right taxes, you could face IRS penalties and interest. In most cases, the IRS comes after the business to collect unpaid taxes. However, the IRS may try to collect taxes from the employee as well, which could create a sticky situation for employee relations.

How to Report Taxable Fringe Benefits

Now, let’s cover how you, as the employer, can report taxable fringe benefits properly.

Step 1: Value the Fringe Benefits

In many cases, valuing a fringe benefit is simple because its fair market value is the same as its cost. For example, if you pay a $1,000 cash bonus to an employee, the value is $1,000. But some fringe benefits are a little tougher to value. Fortunately, the IRS provides guidelines for valuing many common fringe benefits in Publication 5137, Fringe Benefit Guide.

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Employer-provided vehicles are one example. If you provide a company car to an employee that’s used only for business purposes, you don’t have to include the use of that vehicle in the employee’s income. However, if the employee uses the vehicle for both business use and personal use, the personal portion is taxable income. Publication 5137 provides detailed instructions on the three acceptable methods for valuing those miles.

Step 2: Include the Value of the Fringe Benefit in the Recipient’s Gross Income

If you provide taxable fringe benefits to employees, you need to include the value of those benefits in their wages and include them in Box 1 of their Form W-2 for the year in which they received the benefit.

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For taxable fringe benefits paid to an independent contractor, include the amount on the recipient’s Form 1099-NEC at year-end. For taxable benefits paid to partners in a partnership or members of a limited liability company (LLC), include the amount on their Schedule K-1.

Step 3: Withhold Taxes on Benefits

If you use payroll software, enter the value of the fringe benefits into your payroll software and it should withhold federal and state income taxes and employment taxes correctly. Then your employees won’t have to pay taxes on those benefits out of pocket when they file their income tax return.

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Because partners and LLC members don’t receive a paycheck or have taxes withheld from their compensation, you don’t need to withhold taxes on their fringe benefits.

What Are Tax-Free Fringe Benefits?

Nontaxable fringe benefits aren’t included in the employee’s taxable income, and you don’t have to withhold income or employment taxes on them. IRS Publication 15-B includes a complete list of all nontaxable employee benefits, including:

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• Health, dental and vision benefit plans
• Achievement awards (up to $1,600 per calendar year)
• On-site athletic facilities, such as a gym or tennis court
• Dependent care assistance (up to $5,000 per calendar year)
• Educational assistance programs and tuition reimbursement (up to $5,250 per calendar year)
• Employee discounts
• Employee stock options
• Employer-provided cell phones
• Group term life insurance coverage up to $50,000
• Health savings accounts (HSA)
• Lodging on your business premises
• Retirement planning services
• Commuter benefits (up to $270 per calendar year)
• Accident insurance
• Health flexible spending accounts
• No additional-cost services, such as free flights for airline employees

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One exception is adoption assistance. If you provide adoption assistance benefits to employees, you don’t have to withhold federal income taxes, but you do have to withhold Social Security and Medicare taxes and federal unemployment taxes (FUTA).

De Minimis Fringe Benefits

You also don’t have to include de minimis (i.e., minimal) fringe benefits in an employee’s gross income or withhold payroll taxes. De minimis fringe benefits are perks you provide with such a low dollar value that tracking and accounting for them would be impractical. These benefits are deductible business expenses, but they’re excludable from the employee’s gross income.

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Some examples of de minimis fringe benefits include:

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• Occasional use of the company’s copy machine
• Flowers or items given to employees, such as holiday gifts, birthday gifts, and other special occasions (typically limited to $100 per employee)
• Occasional tickets to a sporting event or concert
• Snacks, coffee, and soft drinks provided in the employee break room

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Just keep in mind that tax law doesn’t allow cash, gift certificates, gift cards, in any amount, to qualify as a de minimis fringe benefit. So these kinds of gifts are always taxable fringe benefits.

Are Fringe Benefits Worth It?

Tracking taxable vs. nontaxable fringe benefits might sound confusing, but they can be an effective way to hire top talent, improve job satisfaction, and hold on to valuable employees.

If you need help figuring out which employee benefits are taxable, valuing and reporting them, talk to a tax professional or your payroll provider. They can help you comply with the tax laws and avoid running afoul of IRS rules.