As the job market tightens, companies competing for talent must offer not only competitive pay but also a menu of benefits. Benefits can help attract and retain good employees and can potentially cut down on the costs of finding and training new workers. These benefits can also help you save on taxes.
Overview of tax savings on benefits
Just like wages, salary, commissions, and bonuses you pay to your staff, the cost of employee benefits is tax deductible. In addition, there can be employment tax savings. If instead of offering benefits, you raise employees' compensation, the additional compensation costs you employment taxes.
More specifically, you pay 6.2% for Social Security taxes on compensation up to the annual wage base ($127,200 in 2017). And you pay 1.45% in Medicare taxes on all compensation. But many types of employee benefits are treated as tax-free compensation and are exempt from Social Security and Medicare (FICA) taxes.
Benefits exempt from FICA
Two of the most popular employee benefits—health insurance and employer contributions to qualified retirement plans—are not subject to FICA. But these aren't the only benefits that can be offered free from FICA. Here is a roundup of these employee benefits:
- Achievement awards. Awards you give to employees for length of service are exempt from FICA up to a set dollar limit ($1,600 for qualified plan awards; $400 for nonqualified awards).
- Cell phones. As long as the primary reason for providing the phones to employees is for business and not merely as compensation, then the cost is exempt.
- De minimis fringe benefits. Coffee in the break room, an occasional taxi ride home at night, and flowers for a personal occasion are examples of de minimis benefits that are tax-free, but cash (including gift cards) in any amount is taxable.
- Dependent care assistance. Employer-paid assistance is exempt up to $5,000 annually.
- Educational assistance. Non-job related assistance is exempt up to $5,250 each year. If the courses are job-related, then there's no dollar limit on the amount that is exempt.
- Group term life insurance. The cost of coverage up to $50,000 is exempt. Coverage for a spouse or dependent is exempt only up to $2,000.
- Health savings accounts (HSAs). Employer contributions to employees' accounts are exempt up to the dollar limit per year. (In 2017, it is $3,400 for self-only coverage and $6,750 for family coverage).
- Meals and lodging. The value of providing these benefits on company premises for the convenience of the employer is exempt.
- Moving reimbursements. If an employer is relocating a new employee and pays for moving expenses, the cost is exempt if the employee could have claimed a deduction on his/her personal return (i.e., the employee meets the conditions for a deduction).
- Retirement planning services. The cost is exempt from FICA. However, tax return preparation costs, which may be a benefit for executives and managers, is not.
- Transportation benefits. The cost of free parking, transit passes, and van pooling is tax-free up to a set monthly limit ($255 in 2017).
Benefits not exempt from FICA
While there are many benefits that can be offered to employees that are exempt from FICA, there are some that are not exempt. For example, adoption assistance, which is tax-free to employees up to a set dollar amount each year ($13,570 in 2017), is still subject to FICA.
Special concerns for S corporation owner-employees
While shareholders of S corporations who work in their companies are employees, they cannot enjoy the same benefits in all cases. Here are some exceptions that apply to shareholders owning more than 2% of the stock:
- Achievement awards are not tax-free to the shareholder-employees and are not exempt from FICA.
- Group term life insurance cannot be used as a tax-free fringe benefit to owner-employees. They are treated as a partner in a partnership for purposes of this fringe benefit. Thus, the benefit is treated as taxable compensation subject to FICA.
- Health insurance must be included in a shareholder-employee's compensation. They can deduct the premiums as an adjustment to gross income on Form 1040. However, the coverage is exempt from FICA.
- Health savings account contributions are treated as distributions.
- Meals and lodging for an owner-employee on company premises are not tax-free benefits.
- Moving reimbursements are not tax-free benefits exempt from FICA.
- Transit passes treated as tax-free are capped at $21 per month. If the cost exceeds $21, then the full amount is taxable.
As an employer, you may devise additional fringe benefits to help your staff while saving taxes. If the benefits qualify as de minimis fringe benefits or a working condition fringe benefit (one that would be deductible by the employee if they paid for them), then your employees enjoy the benefit tax free and you won't owe FICA on them.