Fringe Benefits: What They Are and How They Are Taxed
Fringe benefits are additional forms of compensation beyond money. While the term “fringe” may suggest that these benefits are uncommon, they are in fact ubiquitous among employees. Health benefits, for example, are offered to about 75 percent of all U.S. employees, according to the Bureau of Labor Statistics – but they’re considered a fringe benefit for taxation purposes.
Regarding taxation, fringe benefits can cause employers a lot of confusion. Some of these benefits are taxed like standard income, while others are tax-deferred or tax-exempt.
Here, we’ll address fringe benefits, what they include and how they are taxed from both the employee’s and employer’s standpoint.
A List of Common (and Not So Common) Fringe Benefits
In the never-ending effort to attract high-level professional talent, businesses may offer an array of benefits beyond cash compensation. No matter what these extra benefits are, they are considered fringe benefits. Some of the most common examples include:
- Health benefits, including health savings accounts
- Retirement plans
- Life insurance
- Stock options
- Educational and tuition assistance
- Access to fitness facilities
- Employee discounts
- Dependent care benefits
- Transportation benefits
- Various low-value, onsite working benefits (employer-provided snacks, merchandise, or gifts)
Some less common fringe benefits include:
- Mental health benefits
- Wellness benefits, such as paid membership to a fitness center
- Moving expenses
- Access and use of company vehicle
- Employer-provided laptops or cell phones
- Achievement awards
- Adoption assistance
Employers may offer additional benefits that are unique to their organization. For example, many restaurants provide free or reduced-cost meals to their employees, while others have enhanced onsite amenities for workers. Still others offer additional paid-time off or additional maternity or paternity leave.
The Taxation Rules Regarding Fringe Benefits Are Complex
The IRS maintains a complex rule set for fringe benefits. Some are excluded from income taxes entirely, others are only taxed at a certain point, while others must be included in the employee’s taxable income. In general, the following benefits are tax-exempt either entirely or with notable exceptions:
- Accident and health benefits – Tax-exempt except for long-term care offered through a flexible spending account (FSA).
- Achievement awards – Exempt up to $1,600 for qualified plan awards and $400 for nonqualified awards.
- Adoption assistance
- Access to athletic facilities – Exempt as long as the facility is primarily used by employees and their families. Further, the facility must either be operated by the employer or leased by the employer.
- De minimis benefits
- Dependent care assistance – Exempt up to a $5,000 limit (or $2,500 for a married couple filing separately)
- Educational assistance – Exempt up to $5,250 in educational expenses per year. There are additional stipulations (the educational course cannot involve sports, games, or hobbies unless they are related to your business). Nondiscrimination rules also apply to all educational assistance plans.
- Employee discounts – Exempt up to certain limits. These limits are determined by what the business charges customers for services, or – in the case of merchandise – the gross profit margin on the item. These limits can be confusing and change from year to year, so consulting with a tax expert is highly recommended here.
- Employee stock options – Exempt, with a tangle of stipulations. For example, if the value of stock options exceeds their fair market value, the excess must be reported on the employee’s wages. Also, employees may choose to defer the income value of stock options up to five years in some cases. There are many more considerations here, so again, consultation with an expert is recommended.
- Employer-provided cell phones – Exempt as long as the phone is required for business purposes (the employee must be always reachable, the employee must communicate with people outside their time zone, etc.). Further, only a portion of this fringe benefit is exempt – equal to the portion of cell phone use dedicated to business use. Personal use is not exempt.
- Group-term life insurance.
- Health savings accounts (HSAs) – Exempt with limits and eligibility requirements apply (as well as nondiscrimination rules). The employee must be covered by a high deductible health plan (HDHP) to be eligible. For 2023, employer limits are $3,850 (for self-coverage only) or $7,750 (for family coverage).
- Meals – Exempt if provided on the company’s premises or if de minimis.
- No-additional-cost services.
- Retirement planning services.
- Transportation services – Exempt if de minimis. Also exempt if it applies to a ride in a commuter highway vehicle, a transit pass, or for parking. In these instances, the limit is $300.
- Tuition reduction – Exempt for undergraduate education or for graduate education if the employee also provides teaching or research services.
- Working conditions benefits.
For most of these fringe benefits, nondiscrimination rules apply to how they are offered to employees. And in most cases, any tax-exempt fringe benefits are also exempt from Social Security and Medicare taxes.
Nondiscrimination Rules Associated with Fringe Benefits
Nondiscrimination rules state that employers must give all employees an equal chance to access the company’s benefits. These rules also prevent employers from leveraging tax-favored benefits for themselves but not for their employees.
If an employer offers fringe benefits that favor high-income or “key” employees, then the employer must include the value of those benefits in the employee’s wages. The income threshold for highly compensated employees is different depending on the benefit – for most it’s $135,000, though the threshold is $200,000 for some fringe benefits. Key employees are either a high-ranking officer in the organization, meet a high-income threshold, or own a certain portion of the company (1 or 5 percent depending on income).
Cafeteria Plans Give Employees Additional Flexibility with Their Benefits
Cafeteria plans have nothing to do with food or meals. They’re called such because with a cafeteria plan, employees are allowed to choose from a list of fringe benefits (like choosing from a menu) that they opt into. If a cafeteria plan offers nontaxable options, then employees may receive or pay into these benefits without incurring taxes (exceptions and limits still apply). The reverse is true, too – taxable fringe benefits must be included with the employees’ wages.
Fringe Benefits Come with Complicated Tax Provisions, So Speak with a Trusted Tax Professional Before Proceeding
Fringe benefits can be endlessly confusing for business owners. There’s a staggering number of rules and exceptions in play, and they can be quite different from company to company, depending on the fringe benefits they offer. Also, the picture can change instantly as businesses grow, take on additional employees, and change their benefit plans.
Given the major complexities involved, it’s a good idea for business owners to consult with their tax professional when fringe benefits are involved. Doing so can save an organization thousands and help avoid any tax-related compliance issues.
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