Offering fringe benefits is an effective way to recruit new employees and retain existing ones. In many cases, the types of fringe benefits a small business offers can put them on competitive footing with larger rivals. At the same time, if you're an employer who chooses to bestow such benefits on your trusted employees, it's imperative to know if those benefits are subject to federal income tax withholding and employment taxes.
"An employee 'fringe benefit' is a form of pay other than money for the performance of services by employees," notes attorney and author Stephen Fishman. "Any fringe benefit provided to an employee is taxable income for that person unless the tax law specifically excludes it from taxation."
The IRS publication 15-B, "Employer's Tax Guide to Fringe Benefits," lists some of the most frequently encountered fringe benefits that are taxable, such as:
- Repayment of expenses for an employee's relocation of less than 50 miles
- Clothing provided to an employee "that is suitable for street wear"
- Reimbursement for assisting an employee with education when it is not related to his or her job or exceeds the allowable IRS exclusion
- Any expense reimbursement that doesn't come with adequate accounting.
Other taxable benefits include:
- Vacation, athletic club membership, or health resort expenses
- The amount paid to employees for moving expenses in excess of actual expenses
- Business frequent-flyer miles converted to cash
- Group term life insurance provided to employees in excess of $50,000
Use of the company car is a common employee benefit. According to the IRS, when an employee uses that company car for occasional personal driving, the value of that personal use must be noted in the employee's income. In many such cases, the employer reports "a percentage of the car's annual lease value as determined by IRS tables."
So what employee benefits aren't taxable?
Among the most common are what are known as "De Minimis" fringe benefits. These include "any property or services an employer provides his employees that have such a small value that accounting for it would be unreasonable." These include:
- Personal use of an office copy machine
- Occasional tickets to a theater production or other entertainment
- Non-cash holiday gifts
- Soft drinks, coffee, doughnuts
Other types of tax-free benefits include employee discounts on products or services the business sells or offers; meals provided to an employee who's asked to work away from home overnight; health insurance (up to a specified dollar figure); educational assistance (related to the employee's job responsibilities); employee stock options and the costs of lodging on a business's premises. Working condition fringe benefits are tax-free to the employee, according to the IRS publication B-15, "to the extent the employee would be able to deduct the cost of the property or services as a business or depreciation service if he or she had paid for it." Things get a bit more complicated if and when personal use is involved.
If you're unclear about the taxable status of your employee fringe benefits, review them with a tax attorney and always maintain comprehensive records to respond to any IRS inquiry.