Tax Treatment of Fringe Benefits
The term “fringe benefit” refers to any benefit provided to an employee that is in addition to money. All benefits provided to an employee are taxable unless the law specifically excludes or defers tax on the benefit. Thus, a fringe benefit can either be taxable, tax-deferred, or excluded from taxation.
The personal use of an employer-provided vehicle is an example of a taxable fringe benefit. An employer contribution to a qualified retirement plan on behalf of the employee is an example of a tax-deferred fringe benefit. Employer-provided health insurance for an employee is an example of a tax-free fringe benefit.
A small business owner in a corporate setting may be both the owner and an employee of his or her business. By taking advantage of excludable fringe benefits, the owner receives a double benefit. First, the cost of the benefit is deductible by the business. Second, the cost of the benefit is tax free to the employee-owner.
Nondiscrimination Rules for Fringe Benefits
Nondiscrimination rules are designed to prevent business owners from offering tax-favored fringe benefits to themselves but not their employees. In general, if fringe benefits are offered to all employees, then all employees, including the top paid employees, receive tax-favored treatment on employee benefits. However, if a plan favors highly-compensated employees or key employees, the value of the benefit must be included in their taxable wages. The terms highly-compensated employees and key employees can mean different things. depending on the applicable plan. Special restrictions apply for fringe benefits for sole proprietors, partners, certain LLC members, and S corporation shareholders. Consult your tax advisor if you are a business owner considering providing fringe benefits to yourself and your employees.
If an employer provides an employee with a company owned vehicle, and the employee uses the vehicle for personal purposes, the value of that personal use must be included as taxable income on the employee’s Form W-2. Under the general rule, the taxable amount equals the fair market value of the total use, minus the amount the employee pays for the use.
Employer-Provided Cell Phones
The value of an employer-provided cell phone, provided primarily for non-compensatory business reasons, is excludable from an employee’s income.
Noncompensatory Business Purposes
An employer needs substantial business reasons for providing the cell phone. Examples include:
- Need to contact the employee at all times for work-related emergencies,
- Requirement that the employee be available to speak with clients at times when the employee is away from the office, and
- Need to speak with clients located in other time zones at times outside the employee’s normal workday.
The value of cell phones provided to promote goodwill, boost morale, or attract prospective employees cannot be excluded from an employee’s wage.
Dependent Care Assistance
Up to $5,000 ($2,500 for Married Filing Separately filing status) of dependent care benefits provided under a dependent care assistance program is excludable from taxable wages. Although these benefits are reported in box 10 of the employee’s Form W-2, they are not taxable if used for providing qualified care. The benefits are reported with the tax return on Form 2441, Child and Dependent Care Expenses. If benefits received are more than the amount that can be excluded, the excess is included as taxable wages on Form 1040. If an employee receives dependent care benefits, it is still possible for the employee to claim a tax credit for additional expenses.
Other Fringe Benefits
Additional fringe benefits for employees may include:
- Use of on-premises athletic facilities.
- Low-value or de minimis benefits.
- Employee discounts.
- Up to $50,000 group-term life insurance.
- Health benefits.
- Certain business-related meals and lodging.
- Moving expenses.
- Up to $5,250 of educational assistance.
- Transportation benefits.
- Certain benefits provided as a working condition.
A cafeteria plan allows employees to choose between receiving taxable compensation or a qualified benefit for which the law provides an exclusion from taxation. If the employee chooses the benefit, it is excluded from taxation. Cafeteria plans are sometimes referred to as “flex plans,” “flexible spending arrangements,” or “FSAs.”