As an employer, you’ve heard about benefits before. But what are fringe benefits?
To understand fringe benefits, first it’s important to understand how employees are paid. Employees are normally paid wages via written or printed checks, direct deposit, payroll cards, or sometimes cash.
All wages paid to employees are taxable income, and subject to income tax withholding.
Employers are also required to provide certain benefits to their employees (i.e., workers’ compensation coverage, and contributions to state disability programs), and some employers want to offer other benefits as a way to reward, attract, or retain quality employees.
So, what are fringe benefits, and are they subject to income taxes as well?
What Are Fringe Benefits?
IRS Publication 15-B, the Employer's Tax Guide to Fringe Benefits, defines a fringe benefit as “a form of pay for the performance of services.” The employer is the provider of the fringe benefit, even if a third party provides the actual benefit. For example, an employee may receive legal services through an attorney that is paid by the employer, but the employer is still the provider of the fringe benefit.
Fringe benefits like FSAs can be confusing, but they don't have to be.
Similarly, the employee is considered the recipient of the fringe benefit in exchange for services, even if the fringe benefit is provided to someone who didn’t perform the services. For example, if an employee’s family member benefits from a company-sponsored gym membership, the employee will still be considered the fringe benefit recipient.
Here are some other examples of fringe benefits:
- Transportation benefits
- Employee stock options
- Health Savings Accounts
- Athletic facilities
- Tuition reduction
- Adoption assistance
- Achievement awards
Fringe Benefits Are Taxable, With Exceptions
So, as an employer, how do you know what counts as reportable fringe benefits? Nearly all fringe benefits are taxable. The value of a fringe benefit is subject to federal income tax, Social Security tax, Medicare tax, and FUTA, and the value must be included in Boxes 1, 3 and 5 of Form W-2, and on line 3 of Form 940.
However, the taxable portion of a fringe benefit may be reduced by the following amounts:
- Any amount that the law excludes from compensation, such as low-cost holiday gifts or achievement awards; and
- Any amount that the recipient pays for the benefit.
It’s a mistake to assume that a fringe benefit may not be taxable because it isn't specifically listed anywhere in the tax law or one of the IRS publications. The only fringe benefits that are listed in the tax laws are those that can be excluded from income, either in whole or in part.
Additionally, any or all of a fringe benefit can be excluded from taxable income only if the recipient is an employee. If the recipient of a fringe benefit is not an employee, then it is not subject to any income tax withholding, but it may have to be reported as income on one of the following information returns:
- If an independent contractor is the recipient, report the value on Form 1099-MISC, in Box 7: Nonemployee compensation.
- If a partner is the recipient, report the value on Schedule K-1 (Form 1065), in Box 4: Guaranteed payments.
Classifying An Employee As a Non-Employee For Specific Fringe Benefits
For certain fringe benefits, an individual who is normally treated as an employee, may be classified by definition as a non-employee.
The following is a list of employees who may not be treated as employees for certain fringe benefits:
- An employee who owns more than 2% of the stock in an S-Corporation [S2%].
- A highly compensated employee (HCE) who is either an officer, a shareholder who owns more than 5% of the voting power, highly compensated based on the circumstances, or a spouse or dependent of a person described above [HCE5%].
- An HCE who is either one of the five highest paid officers, owns more than 10% of the employer's stock, or is among the highest paid 25% of all employees. [HCE10%]
- An HCE who is either a 5% owner at any time during the year or the preceding year, or received more than $115,000 in pay for the preceding year. [HCE$115]
- A key employee who is either an officer having annual pay of more than $170,000, or an employee who is either a 5% owner of the business or a 1% owner of the business whose annual pay is more than $150,000. [Key]
If you’re looking for a complete list of fringe benefits excluded from income taxes, be sure to read IRS Publication 15-B, the Employer’s Tax Guide to Fringe Benefits.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, legal or tax advice. If you have any legal or tax questions regarding this content or related issues, then you should consult with your professional legal or tax advisor.