As a small-business owner, you may choose to provide your workers with fringe benefits on top of their normal pay rate. Fringe benefits are a form of compensation given in exchange for the performance of services, and can be provided to full- and part-time employees, independent contractors, and partners.
Some people assume these perks are given and received free from taxation, but this isn’t always the case. In general, fringe benefits are taxable to the employee and are subject to withholding and employment taxes, but there are exceptions. To avoid any surprises at tax time, it's important to understand which fringe benefits are taxable and which benefits are nontaxable.
Taxable Fringe Benefits
Taxable fringe benefits are included in gross income and subject to federal withholding, social security, and Medicare taxes. Examples of taxable fringe benefits include:
- The value of the personal use of an employer-provided vehicle
- Group-term life insurance in excess of $50,000
- Vacation expenses
- Frequent-flyer miles earned during business use, converted to cash
- Amounts paid to employees for relocation in excess of actual expenses
Employers and employees are required to claim the fair market value of taxable fringe benefits. Fair market value is defined as the amount someone would pay if they were to acquire the item or service on their own (i.e. how much it would cost an employee to buy or lease the benefit from a third party outside the work environment). This may differ from the amount an employer paid for the benefit because companies may receive corporate discounts.
Taxable fringe benefits are usually subject to withholding when they are made available. Employers can choose to treat taxable fringe benefits as paid in a pay period, quarterly, semi-annually, or annually — but all benefits must be treated as paid no later than December 31 of the calendar year they were provided.
Taxable fringe benefits paid by the employer to an employee are reported on Form W-2 (taxable fringe benefits provided to independent contractors are reported on Form 1099-Misc and taxable fringe benefits paid to partners are reported on Form 1065). Employees are required to claim the fair market value of all taxable fringe benefits on their annual personal income tax return.
Nontaxable Fringe Benefits
Certain fringe benefits are not subject to federal income tax withholding and are excluded from gross income. These benefits are, in general, also not subject to social security, Medicare, or FUTA taxes and are not reported on Form W-2. A complete list of all nontaxable fringe benefits can be found on the IRS website, but a few examples include:
- Employee discounts
- Employee stock options
- Group-term life insurance up to $50,000
- Health flexible spending accounts
- Retirement planning services
- Job-related tuition assistance reimbursements
This article is a just a cursory overview of fringe benefits. Employers should consult the IRS’ Fringe Benefit Guide for an in-depth guide to federal tax laws related to fringe benefits, or seek legal, accounting or other professional advice to ensure you are properly withholding and reporting applicable fringe benefits.