Tricky Tax Angles to Fringe Benefits
Competition for top-notch workers can be fierce. Your business currently may be understaffed due to a number of factors — including the "Great Resignation" and "quiet quitting" where employees do the bare minimum before eventually leaving. A proven way to help attract and retain the cream of the crop is to expand or enhance your company's fringe benefits package.
While salary is essential to current and prospective employees, don't discount the significance of fringe benefits. In fact, a whopping 92% of employees say that benefits are important to their overall job satisfaction, according to the Society of Human Resource Management (SHRM).
Overview of the Tax Rules
The term "fringe benefit" refers to a provision or payment to eligible employees that goes beyond regular wages and bonuses. Typically, fringes are comprised of goods, services or cash equivalents. Depending on the type of benefit, it may be available to salaried and hourly workers — including the CEO or business owner — and, in some cases, even independent contractors.
As with other forms of compensation, fringe benefits are generally taxable to recipients. However, there are some special exceptions that may be both tax-exempt to the participating employees and tax-deductible by the business entity, subject to certain restrictions. Thus, an entire cottage industry has sprung up around the tax treatment of fringe benefits.
The list of tax-exempt statutory fringe benefits has grown over the years. Here are some popular examples:
Achievement awards. The tax law defines "achievement award" as an item of tangible personal property granted for either length of service or promoting safety. For a written qualified plan, the maximum tax-free award is $1,600, while the maximum for a nonqualified plan is $400.
Athletic facilities. Employees can use an on-site athletic facility tax-free if the employer operates it. Such a facility may be available to employees, their spouses and dependents, as well as retired employees, including the company's founder. This category includes gymnasiums, tennis courts and swimming pools.
Dependent care assistance. The first $5,000 of dependent care assistance paid by an employer under a written plan is tax-free to employees. To qualify, a dependent must be either 1) a child under age 13, or 2) a spouse or a relative who is physically or mentally incapable of self-care and lives in the employee's home.
Educational assistance plans. A company can provide tax-free payments of up to $5,250 for college or graduate school tuition, books, fees and supplies through an educational assistance plan. The courses covered under the plan don't have to be related to the job, but courses involving sports, games or hobbies are covered only if the course is job-related or required as part of a degree program.
Employee discounts. A company can provide tax-free discounts to employees on its products or services. For products, the discount percentage can't exceed the gross profit percentage of the price at which the product is offered to regular customers. For services, the discount percentage can't be more than 20% off the price at which the service is offered to regular customers.
Group-term life insurance. This is usually a prized perk for highly paid executives, but only the first $50,000 of coverage is tax-free. The tax on any excess coverage is computed under an IRS table based on the insured's age.
Health insurance. Premiums paid by an employer under a health insurance plan are tax-free to employees — and deductible by the employer — as long as the plan is open to the rank and file. Similarly, employer reimbursements for medical expenses are generally tax-free to employees, as are contributions to Health Savings Accounts (HSAs).
Meals and eating facilities. Meals furnished to an employee for the employer's convenience are generally tax-free if they're provided on the business premises. This includes company-operated cafeterias and similar facilities. However, under the Tax Cuts and Jobs Act (TCJA), the employer's deduction is limited to 50% of the cost for 2018 through 2025. After 2025, no deduction will be allowed.
Retirement plans. Usually, the benefits provided through qualified plans — such as pension, profit sharing, SEP and 401(k) plans — are exempt from current tax and can grow without any tax erosion until withdrawals are made. Contributions are subject to generous annual limits, including potential matching employer contributions, but strict nondiscrimination requirements must be met.
Transportation benefits. Benefits for monthly transit, vanpooling and parking privileges may be excluded from tax, up to specific monthly limits. For 2023, the combined monthly limit for mass transit passes and vanpooling is $300, the same as the monthly limit for parking privileges. Caveat: Under a TCJA change, employers can no longer deduct these benefits.
Working condition fringe benefits. This type of fringe benefit includes property or services provided to employees so they can do their jobs. For example, it includes the cost of traveling to visit business clients or attending a business conference. Detailed recordkeeping is required.
Although fringe benefits may be offered by all types of business entities, special rules may apply to partners in partnerships, members of limited liability companies (LLCs) taxed as partnerships and people who own at least 2% of an S corporation. Generally, fringe benefits paid to these business owners are taxable, with some limited exceptions.
For instance, benefits from a dependent care assistance plan are available for S corporation owners, but the benefits for people who own at least 5% of the company's stock can't exceed 25% of the total amount. Similarly, an educational assistance plan can't provide more than 5% of the benefits to S corporation shareholder-employees. And certain di minimis benefits are completely tax-free to all employees.
Finally, be aware of the so-called "family attribution" rules. Notably, family members of people who own 2% or more of an S corporation's stock — including spouses, children, grandchildren and parents — are considered shareholders. So you can't circumvent the fringe benefit rules by providing benefits to employees who are family members.
Get It Right
The tax rules related to fringe benefits are complex. Contact your tax professional to ensure that you're treating these benefits appropriately on your company's tax return and other year-end tax forms sent to employees, contractors and owners.
Which Fringe Benefits Are Taxable? Here's a partial list of benefits that are taxable to employees under current law:
Excessive mileage reimbursements,
Gym and club memberships,
Work clothing suitable for regular (non-work) wear,
Cash awards and prizes (except for achievement award plans),
Use of a company car for personal purposes,
Personal use of other working condition fringe benefits, and
Moving expense reimbursements (except for armed forces personnel).
Important: Under the Tax Cuts and Jobs Act, employers must include job-related moving expense reimbursements as taxable income on employees' W-2s (except for active-duty members of the military) for 2018 through 2025. This provision is scheduled to expire in 2026, unless Congress extends it.
Employers should understand all the rules and inform employees about the tax consequences. Contact your tax advisor for more information.But favorable tax treatment for fringe benefits isn't automatic. In addition, there are several potential twists and turns to consider.
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