What To Know About Fringe Benefits for Your Employees
As a small business owner, you may choose to provide your workers with additional benefits on top of their regular pay rate. Offering these benefits can be an effective way to recruit and retain top talent, but some benefits could be taxable. To avoid unnecessary surprises at tax time, it's important to understand how these benefits work, which benefits are legally required, and how to identify which benefits are taxable.
What are Fringe Benefits?
Fringe benefits are a form of pay, often from employers to employees, and are considered compensation for services beyond the employee's normal rate of pay. They can be made in the form of property, services, cash, or cash equivalents. Cash equivalents are things that can be turned into cash fairly quickly, such as savings bonds. Generally, fringe benefits are taxable to the employee, must be included as supplemental income on the employee's W-2, and are subject to withholding and employment taxes. The IRS provides guidance on fringe benefits in a publication titled Employer's Tax Guide to Fringe Benefits For Use in 2021.
How Do Fringe Benefits Work?
As outlined above, fringe benefits for employees can take the form of property, services, cash, or some cash equivalent. They can also include non-tangible benefits, such as the use of a company car, life insurance, or flex time built into a work schedule. Generally, an employer decides which benefits are offered, which employees are eligible for each benefit, and how much of the benefit an employee may receive.
Fringe Benefit Examples
Certain types of fringe benefits are restricted by federal labor laws and employment regulations. While employers do have some latitude in how they offer fringe benefits, some benefit types will have tax implications, and other benefits are legally required for employers that fit certain criteria. Generally, all fringe benefits fall into three categories — legally required benefits, taxable benefits, and non-taxable benefits.
Examples of Legally Required Fringe Benefits
Some employers are legally required to provide certain benefits to employees, based on the size of the company and the number of full-time employees. Some fringe benefits, such as workers' compensation, are required for most employers in most states, but the amount of workers' compensation required may vary based on local or state laws.
For the most accurate information on which benefits are required for your employees, it's best to review your local and state laws or consult a benefits professional. Examples of fringe benefits that are required for at least some employers include:
- Workers' compensation
- Unemployment insurance
- Family and medical leave
- Health insurance
Examples of Taxable Fringe Benefits
Some people assume these perks are given and received free from taxation, but this isn't always the case. In general, fringe benefits with significant value are considered taxable to the employee and subject to federal withholding, Social Security, and Medicare taxes. The fair market value of the benefit is added to the employee's gross income and reported on the employee's W-2 form, along with any applicable taxes withheld. Examples of taxable fringe benefits include:
- Vacation, athletic club membership, or health resort expenses
- Value of the personal use of an employer-provided vehicle
- Amounts 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
Examples of Non-Taxable 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:
- Employer-provided spending accounts such as medical flexible spending accounts and dependent care accounts
- Payments made on employees' behalf for public transportation to and from work and parking while at work
- Up to $5,000 paid by the employer for child- or dependent-care services
- Group term life insurance provided to employees, up to $50,000
- No additional cost services such as complimentary flights for airline employees
- Employee discounts
- Working condition fringe benefits such as the use of company vehicles
- Tuition reduction
- "De minimis" fringe benefits such as employee use of office equipment, non-cash holiday gifts, parties or picnics, and entertainment events where the value of the benefit is considered minimal
- Athletic facilities primarily used by employees, if located at the place of employment
- Retirement planning services
- Adoption assistance program
- Use of business frequent flyer miles for personal travel
- Moving expense reimbursements for actual costs paid or incurred
Valuing Fringe Benefits
The general rule for placing a value on a fringe benefit is to use the fair market value of the benefit given. In many cases, the fair market value and the cost of the item are the same, but fair market value may be higher than the actual cost if the employer was able to purchase the item at a discount. For taxation purposes, fair market value is generally considered to be whatever a willing buyer would pay for an item of equal value. In some cases, the IRS provides specific guidance on how to value items, which is provided in the IRS Fringe Benefits Guide.
To evaluate the fair market value of an item, comparing the retail cost of a similar product can provide a good estimate of the benefit's value. For example, if employees are provided with an annual membership to a local gym, the gym's regular price for an annual membership for an adult would be a good valuation amount, even if the employer was able to negotiate lower bulk pricing.
Employer Tax Treatment
Reporting requirements differ based on who receives the benefit. For example, taxable fringe benefits paid by the employer to an employee are included in the employee's annual W-2 statement, but taxable fringe benefits paid to independent contractors are reported on the Form 1099-NEC. Taxable fringe benefits paid to partners are reported on Schedule K-1 (Form 1065).
Incorporating fringe benefits into a hiring and retention program can be a great way for employers to source and retain top talent. However, to use fringe benefits effectively, employers should know about the types of fringe benefits, whether they are taxable, and how to value them appropriately. Employers planning to incorporate new fringe benefits should consult the IRS' Fringe Benefit Guide for in-depth information related to federal tax laws on benefits, or seek other professional advice to ensure your benefits are reported and taxed properly.