Fringe Benefit Considerations for Small Businesses
Small business owners have many responsibilities. One of those responsibilities is accurately reporting all forms of compensation paid to employees, including fringe benefits. There are many questions that surround fringe benefit reporting regarding what fringe benefits are, when they are considered taxable compensation, and if there are any exclusions from the fringe benefit reporting rules. This article overviews examples of both nontaxable and taxable fringe benefits and how to account for them.
A fringe benefit is a form of compensation, cash or noncash, for the performance of services. While the IRS does not provide a specific definition of fringe benefits, it does provide examples of payments that are considered taxable and nontaxable fringe benefits.
Fringe benefits can be provided to both employees and independent contractors. They are generally considered additional taxable compensation unless they are specifically excluded by Internal Revenue Code Section 132. This article will focus only on payments made to employees.
Nontaxable fringe benefits are not subject to income or payroll taxes. Some of these nontaxable benefits require a specific written plan that does not favor highly compensated employees to qualify for tax-free treatment. Other benefits have specific definitions of employees and who can qualify to receive the benefit. Below are some examples of nontaxable fringe benefits as detailed in IRS Publication 15-B, Employer’s Tax Guide to Fringe Benefits:
- Accident and health benefits – This includes health insurance provided for employees, their spouses, dependents, and their children (under the age of 27). The plan does not have to be in writing.
- Achievement awards – Tangible personal property given to an employee for either length of service or a safety achievement. This exclusion has two set dollar amounts that may be excluded from wages. Up to $1,600 in awards may be excluded if given as part of an established written plan that does not favor highly compensated employees. If there is not a written plan, up to $400 may be excluded as a nontaxable fringe benefit. The exclusion does not apply to vacations, meals, lodging, theatre or sporting events tickets, stocks, bonds, and other similar items. Cash and cash equivalents are always considered to be taxable.
- De minimis benefits – De minimis fringe benefits are property or services an employer provides that have so little value that it is administratively impracticable to account for the value. Some examples include personal use of a business-provided cellphone, holidays, or birthday gifts (other than cash) with a low fair market value. Certain de minimis fringe benefits, including cash or gift cards, are not excluded and will be addressed in greater detail below.
- Dependent care assistance – This exclusion applies to household and dependent care services you directly or indirectly pay for or provide to an employee under a written dependent care assistance program that covers only your employees. The services must be for a qualifying person’s care and must be provided to allow the employee to work. You can exclude up to $5,000 of benefits received from gross income of the employee (limited to $2,500 for married employees filing separate returns). The value of all dependent care assistance provided to an employee through the program is reported on Form W-2, Box 10. Any amount provided in excess of $5,000 is taxable to the employee. Amounts paid more than the set limits are taxable wages and reportable on Form W-2, boxes 1, 3, and 5. State and local income rules also should be reviewed to determine whether the excess payments are subject to state or local income taxes.
- Educational assistance – This exclusion applies to educational assistance you provide to employees under a written educational assistance program. The exclusion includes amounts paid or incurred for books, equipment, fees, supplies, and tuition and also applies to graduate-level courses. This exclusion does not apply to working condition benefits—see more on this exclusion below. Section 2206 of the Coronavirus Aid, Relief, and Economic Security Act expands the definition of educational assistance to include certain employer payments of student loans paid after March 27, 2020, and before January 1, 2026, unless extended by future legislation. Under a qualified educational assistance program, an employer can exclude up to $5,250 annually of educational assistance provided to an employee. If an employer does not have a separate written plan or provides assistance in excess of $5,250, the value of those benefits must be included as taxable wages on Form W-2.
- Employee discounts – This exclusion applies to a price reduction given to employees on property (not real property or investments such as stocks or bonds) or services offered to customers in the ordinary course of the line of business in which the employee performs substantial services. The benefit may be provided by an employer or indirectly through a third party. For example, an employee of an appliance manufacturer may receive a qualified employee discount on the appliances purchased at a retail store. An employer can generally exclude the value of an employee discount up to the following limits:
- For service discounts – Up to 20 percent of the price charged to nonemployees for the service.
- For merchandise discounts – Up to the gross profit percentage times the price charged a nonemployee customer.
- Working condition benefits – This exclusion applies to property and services provided to an employee so the employee can perform their job. It applies to the extent the cost of the property or services would be allowable as a business expense or depreciation expense deduction to the employee if they had paid for it. The employee must meet any substantiation requirements that apply to the deduction. Examples of working condition benefits include an employee’s use of a company car for business, employer-provided cellphone provided primarily for business use, and job-related education.
As previously stated, fringe benefits are generally considered additional taxable compensation unless specifically excluded. Taxable fringe benefits are subject to all applicable income and payroll taxes and are included on Form W-2. A few examples of taxable fringe benefits are outlined below:
- Cash and cash equivalents – In general, any cash or an item easily exchanged for cash is taxable.
- Gift certificates – If the employer can readily determine the value, gift certificates are taxable. For example, a gift certificate to a movie theater with a face value of $10 is easily valued and would be taxable, while a free movie pass with no value assigned would not be taxable.
- De minimis benefits – Some of the fringe benefits that are not eligible for tax-free treatment are season tickets to sporting or theatrical events, personal use of an employer-provided vehicle, membership to a private country club or athletic facility, and use of employer-owned/leased facilities (such as an apartment, hunting lodge, boat, etc.).
Properly accounting for fringe benefits can be complex. There are specific requirements that must be met in order for a payment to qualify for tax-free treatment. If you are unsure if benefits you are providing are taxable or not, or if you would like to explore any of these items further, reach out to your BKD Trusted Advisor™ or submit the Contact Us form below. Want to learn more about the services we provide small to midsize businesses? Visit our Outsourced Accounting Service webpage.