Many companies offer extra benefits to attract and retain the best talent. These benefits range from insurance to retirement accounts and bonuses. In the past, only large companies would offer fringe benefits because of the extra cost. Still, it is becoming more popular among small and medium companies just so those companies can retain the best talent.
Although small businesses offer what they can afford, many would prefer to offer many fringe benefits. Those who do need to understand the tax ramifications of certain fringe benefits.
What Are Taxable Fringe Benefits?
The Internal Revenue Service (IRS) defines a fringe benefit as “a form of pay for services.” They are usually included in an employee's gross income and are usually non-wage compensation. Fringe benefits may be fully or partially taxable, depending on the benefit and to whom it is paid.
Taxable fringe benefits may include:
- Health Insurance: Coverage for non-dependent people or excessive coverage amounts are taxable.
- Bonuses and Awards: Bonuses and awards are great ways to motivate and reward employees, but most, including cash bonuses, non-cash awards, and gift cards, are taxable.
- Company Cars: When you provide a company car for business use only, it is usually non-taxable. However, it becomes taxable if the employee can use the vehicle for personal and business reasons.
- Housing Allowances: The housing rules for taxable or non-taxable fringe benefits are complex. Housing allowances may trigger taxable fringe benefits, especially if the housing is not necessary for employment.
- Educational Assistance: The IRS provides limits for non-taxable educational assistance. Anything over those amounts, which can change from year to year, is taxable.
- Meals and Entertainment: Meals and entertainment are only non-taxable under certain circumstances, including “your convenience.” For example, if you provide employee meals on the premises for an employee who works overtime, the meal is not usually taxable.
Calculating Taxable Fringe Benefits
In most cases, the value of the taxable fringe benefit is determined by the benefit’s fair market value. However, the IRS does provide guidelines for many fringe benefits. For example, when you provide a vehicle for an employee and allow the employee to use the vehicle for personal use, the IRS calculates the taxable value based on a standard mileage rate or a percentage of the vehicle’s fair market value.
Reporting and Withholding Requirements
As an employer, you have specific withholding obligations for taxable fringe benefits. If you fail to meet those obligations, you could face penalties and legal consequences. As an employer, you must:
- Report the total value of taxable fringe benefits, including cash and non-cash benefits, on your employees’ W-2 forms.
- Withhold the amount from paychecks. Some fringe benefits are subject to income tax withholding. As an employer, it is up to you to withhold the appropriate amount from your employees’ paychecks. Otherwise, your employees could underpay taxes.
- Withhold the amount as social security and Medicare taxes. Some fringe benefits are subject to social security and Medicare taxes.
- File the required forms, such as 1099-MISCs or W-2s.
Some examples of benefits that are taxable as certain income include:
- Adoption assistance is exempt from income tax, Social Security, and Medicare but is taxable under federal unemployment (FUTA) taxes.
- Dependent care is only exempt up to $5,000 or $2,500 for a married employee filing separately.
- Educational assistance is exempt up to $5,250 each year.
- Group-term life insurance is exempt under income tax and FUTA tax but is only exempt up to $50,000 of coverage under social security and Medicare taxes.
Common Mistakes Made When Working with Taxable Fringe Benefits
Mistakes when calculating taxable and non-taxable fringe benefits can lead to severe repercussions by the Internal Revenue Service. Thus, it is essential to regularly review your benefits programs with a tax professional or a tax attorney to ensure you remain compliant. The tax laws change yearly, making an already tricky payroll area even more difficult.
Some of the common mistakes made by employers include:
- Valuation: Assigning an inaccurate value to taxable fringe benefits could result in underreporting and penalties. In most cases, the value is the fair market value of the benefit.
- Record-Keeping: Always keep complete and accurate records of taxable fringe benefits and non-taxable fringe benefits. Poor record-keeping can lead to reporting difficulties and result in penalties if you get audited.
- Tax Law Changes: The tax laws often change. Some fringe benefits for non-taxable employees may become taxable, and vice versa. Exemption amounts change frequently, often every year. You must remain current on tax law changes.
- Misclassifying Employees: Make sure you know the employment status, e.g., whether the person working for you is an employee or an independent contractor. Additionally, some fringe benefits are available to past employees or the widow or widower of an employee. These individuals may or may not be classified as employees for fringe benefit taxation.
Employee Education and Communication
Fostering a positive work environment means mitigating potential issues. One of the big issues you can mitigate is being transparent about fringe benefits. When employees understand how fringe benefits work, they are more compliant. In addition to including the fringe benefits and their tax ramifications in the employee manual, you should also provide:
- Employee Workshops: You can conduct workshops or information sessions to educate employees about taxable fringe benefits. Provide real-life examples to help them understand the complex tax laws surrounding taxable and non-taxable fringe benefits.
- Clear Communication Materials: Create brochures, digital resources, and other transparent communication materials about the taxable nature of certain fringe benefits. These materials should be readily available to all employees.
- Regular Updates: Always keep employees informed about any changes in tax laws or company policies related to fringe benefits so they always know their responsibilities and rights. When you hear of an update, update the employee manual when necessary.
- Individual Consultations: An employee may have specific questions regarding taxable fringe benefits. Offering individual consultations regarding fringe benefits and the tax repercussions on an employee can help alleviate concerns about unique situations.
Contact Workforce PayHub
An effective human resources office understands taxable fringe benefits. Employers can avoid pitfalls and can fulfill reporting obligations more efficiently. They can also significantly foster transparent communication with employees when the tax law changes or the company adds or removes a taxable fringe benefit.
Contact Workforce PayHub for a consultation to ensure compliance with tax laws. You can also subscribe to our newsletter or blog updates for ongoing information about payroll management.
