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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.
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.
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.
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.
Some examples of taxable fringe benefits are as follows:
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.
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:
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.
A cafeteria plan, established under Section 125 of the IRS Code, is a written plan that lets employees choose between receiving cash or tax-free fringe benefits. Benefits may include accident and health benefits, adoption assistance, dependent care assistance, life insurance, and health savings accounts.
Cafeteria plans must pass discrimination tests to determine if they favor highly compensated employees. Tracking the required data and completing these tests can pose a significant administrative burden, particularly for small businesses.
To make these plans more accessible, the IRS provides a “simple cafeteria plan” that allows small businesses to bypass discrimination testing requirements.
Businesses with up to 100 employees are eligible to enroll, and they can continue in the simple plan until their employee count surpasses 200. To qualify, small businesses can choose to provide benefits equal to one of the following:
These plans are indeed simpler than a standard cafeteria plan, but you’ll still want to consult legal and tax advisors when considering your options.
Yes, all benefits you provide as compensation for services are included in fringe benefits. Since vacation and sick leave are usually already accounted for in an employee’s wages, they may not require specific accounting, but they are still fringe benefits.
Many highly popular benefits are free. Benefits such as remote work options, flexible hours, flexible work days, and casual attire have proven very popular with employees.
Generally, the term “fringe benefits” is reserved for benefits with cash value, since they are given as compensation for services, and that is what triggers IRS reporting and accounting requirements.
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.
Our Small Business Expert
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