What Are Fringe Benefits and Are They Taxable?

The competition for talent is fierce, and businesses are getting more and more creative with employee benefits in an effort to attract top candidates. This strategy can be especially powerful for small businesses.

A recent study by MetLife found that 52% of small business employees are interested in having a wider array of non-medical benefits to choose from, even if they pay for them on their own.

Small businesses can experiment with benefits more easily than their larger counterparts, tailoring their offerings to meet their employees’ needs.

In addition to satisfying the desires of today’s job-hopping workforce, fringe benefits, the perks that sweeten an employee’s compensation package, can provide tax breaks for employers and employees alike.

Before you get creative with employee benefits, though, it’s important to understand what qualifies as a fringe benefit and how to properly assess fringe benefit taxes.

Overview: What are fringe benefits?

Employee fringe benefits are benefits provided as a form of payment for services beyond wages and salaries. They may be given to hourly and exempt employees, partners, directors, contract employees, and independent contractors.

They can consist of cash, gift certificates and other cash equivalents, property, services, or even employee discounts. Because fringe benefits are generally included in an employee’s gross income, it’s important to understand who the provider and recipient are for tax purposes.

Even if fringe benefits are delivered through a third party, the employer is the provider of the benefit. For example, if a company offers its employees free fitness memberships at a local gym, the company is the provider of the benefit, and the value of the benefit is considered part of the employee’s compensation.

Similarly, if a fringe benefit is provided to a third party such as a family member, the employee who earned the benefit is still the recipient. For example, if a company pays for an employee’s spouse to attend a conference, the cost for both attendees would be considered a fringe benefit for the employee.

Despite their complexity, fringe benefits are highly valued for the tax benefits they provide and the flexibility they bring to employee compensation.

Are fringe benefits taxable?

Generally, fringe benefits are included in an employee’s gross annual income and are therefore subject to taxes. These may include federal and state income tax, Federal Unemployment Tax Act (FUTA) taxes, and Federal Insurance Contributions Act (FICA) taxes.

Because the government provides liberal tax exemptions for many fringe benefits, fringe benefits deducted from paychecks can reduce your employees’ tax burdens. They can also reduce your payroll taxes by decreasing Social Security and Medicare contributions.

Fringe benefits examples

All fringe benefits are taxable unless specifically exempted by law. Exemptions for a fringe benefit may apply to one or more payroll taxes. Adoption assistance, for example, is exempt from income taxes but subject to FICA and FUTA taxes.

Life insurance, on the other hand, is exempt from income and FUTA taxes but subject to FICA. The following are examples of fringe benefits along with highlights of their tax treatments.

Taxable fringe benefits examples

Some examples of taxable fringe benefits are as follows:

• Gym memberships: The value of gym memberships is taxable with the exception of on-site fitness centers used almost exclusively by employees and family members.
• Moving assistance: Relocation costs borne by the employer are included in taxable income.
• Cash awards and bonuses: Cash and cash equivalents such as gift certificates are generally fully taxed as income.
• Club memberships: Memberships in clubs unrelated to business purposes are taxable.
• Housing and rent: Employer-provided housing is taxable with the exception of housing on the business premises provided for the employer’s convenience as a condition of employment.

Non-taxable fringe benefits examples

Following are benefits that are generally excluded from taxable income or taxed after a substantial exemption. In every case, the tax laws are highly nuanced, requiring research to determine their application to a specific case. Consult the IRS guide or your tax advisor for guidance.

• Accident and health benefits: Health, accident, and disability insurance are generally exempt from taxes with minor exceptions, as are health savings accounts.
• Achievement awards: Employee achievement awards such as watches or service pins are exempt, but cash and cash equivalents are not.
• Dependent care: Dependent care assistance under $5,000 each year (or $2,500 for married employees filing separate returns) is exempt from taxes. Amounts over the threshold are included in income.
• De minimis fringe benefits: Benefits with minimal monetary value, such as occasional meals, gifts, and free coffee, are exempt. The IRS advises that de minimis benefits must be “occasional or unusual in frequency” and must be of such a low value that accounting for them would be administratively unreasonable. In a specific case, the IRS has ruled that items over $100 in value are never de minimis.
• Educational assistance: This is generally excluded up to $5,250 in annual benefits. Some education benefits may be considered working condition benefits (see below).
• Employee discounts: Discounts of up to 20% on services or the employer’s gross profit percentage on merchandise are not subject to tax.
• Group life insurance: The cost of life insurance is exempt from income tax and unemployment tax. Premiums for policies over $50,000, though, are subject to FICA taxes.
• Employee stock options: Stock options are generally not taxed until exercised. See IRS guidance for details.
• Working condition benefits: Property and services used by employees to perform their jobs are considered working condition benefits and are excluded from taxable income. Examples include company-provided cell phones and use of a company car. However, the exclusion is limited to the amount of the resource that is devoted to the employee’s work. Portions devoted to personal use are generally subject to taxes.
• Parking and commuting benefits: Qualified transportation benefits such as public transit passes, parking expenses, and other commuting assistance may be provided tax-free within prescribed limits.
• Retirement planning services: As long as they don’t stray into tax preparation, accounting, legal, or brokerage services, these services are generally exempt.
• No-additional-cost services: If a business can offer its customary services to employees without incurring substantial costs or forfeited revenue, the services are generally exempt. This includes excess capacity services such as unsold airline tickets made available to employees on a standby basis. (Reserved tickets would be excluded because they could otherwise be sold).

How to calculate fringe benefits for certified payroll

Basically, all fringe benefits are taxable unless the law specifically excludes them. The taxable value of a fringe benefit equals the fair market value minus the sum of the following:

• Any amount excluded by law from pay
• Any amount the recipient paid for the benefit

The IRS has established special rules for calculating fringe benefits, which are detailed in Publication 15-B, Employer’s Tax Guide to Fringe Benefits.

Often, fringe benefits are included in the calculation of prevailing wages for the purpose of meeting state and federal requirements.

When running payroll, fringe benefits are generally subject to withholding when they are awarded to the employee. For employees, the taxable value of fringe benefits is reported on Form W-2. For partners, it is reported on Schedule K-1, and for independent contractors, on Form 1099-NEC.

Payroll software such as OnPay can greatly simplify the accounting and reporting processes for fringe benefits. Tax software can also help ensure that you’re properly managing payroll taxes and other small business taxes.

It pays to be creative

Creative benefits packages are a great way to attract top talent to your company. They also have a powerful influence on employee happiness and retention. When evaluating your benefits package, be sure to investigate the full range of fringe benefits available to you and their potential tax advantages.

Your business and your employees have much to benefit from a well-rounded compensation package.