Fringe benefits are company-paid incentives you offer employees above and beyond their regular salary. They can include traditional employee benefits (such as health insurance and retirement benefits) as long as the employer is contributing to the costs, thereby saving the employee money. Fringe benefits also include less traditional benefits like moving expenses, adoption assistance, or commuter stipends. Fringe benefits are generally taxable, unless specifically exempted by the Internal Revenue Service (IRS).
Understanding these exemptions and how to distinguish taxable fringe benefits from non-taxable ones is key to making sure your business and employees are in compliance with federal tax laws.
Taxable vs Non-taxable Fringe Benefits
According to the IRS, most fringe benefits are subject to taxes. So, you’ll need to deduct taxes for most benefits you offer to employees.
Click through the tabs below for some of the most common taxable fringe benefits, as well as a list of non-taxable fringe benefits as designated by the IRS.
The IRS guidelines for what is taxable and not are very precise. For example, the federal mileage reimbursement standard is 58.5 cents per mile, and it’s not taxable—but you can reimburse more. Any amount you’ve reimbursed over 58.5 cents per mile is taxable income to your employees. So, if you reimburse employees at 75 cents per mile, then 16.5 cents per mile is taxable income.
Similarly, while relocation or moving expenses aren’t usually a taxable benefit, if you offer a $10,000 relocation benefit and it only costs your employee $5,000 to move, the extra $5,000 is taxable income.
Some fringe benefits can even be both taxable and non-taxable, like a computer. If the employee uses the company-provided laptop 90% of the time for work, that would mean 10% of the time the computer is used for personal items. So 10% of the value of the laptop would be taxed at the fair market value. For a $1,000 laptop, $100 would be taxable income to your employee.
Calculating the Fair Market Value
Taxable fringe benefits must be valued so you know what tax rates employees or you need to pay. According to the IRS, the fair market value of a fringe benefit is determined by what a reasonable person would pay for that specific benefit. For example, if your company offers country club memberships to employees, the fair market value would be whatever the country club charges a member annually. If that fee is $20,000, then that’s the fair market value.
If your company pays that entire fee, then $20,000 is taxable income to any employee who chooses this fringe benefit. For such a high cost, however, you may split that cost with employees. In that instance, only the amount your company pays ($10,000) would be taxable income to your employee.
When calculating the fair market value of a fringe benefit, you would use any publicly available information to determine that figure. Using the country club example, your company may be a corporate member that receives discounts on the dues for any of your employees, resulting in an actual membership cost of less than $20,000. However, you’re still able to use the $20,000 figure for taxation purposes, even if your actual cost is less.
Fringe Benefit Tax Rate
As the employer, it’s your job to withhold appropriate taxes for any benefits. But you and your employee have options on your withholdings. You can elect to tax fringe benefits at the employee’s income tax rate. Or you can choose to withhold a flat 22% of the benefit value.
Withholding at a flat rate may be simpler for your processing, but it could result in a higher tax due or tax refund for your employee at the end of the year. It’s recommended to consult with your employees to figure out what they would prefer.
To include taxable fringe benefits when doing your regular payroll, first determine the fair market value of each benefit received for each employee. Then subtract any non-taxable fringe benefits. The remaining number will represent the total taxable fringe benefit amount for your employees. At the end of the year, add the total amount to each employee’s W-2 form.
Offering Fringe Benefits for Your Small Business
When considering fringe benefits to offer your employees, think about some of the traditional benefits that your company can contribute to (covering part or all of your employees’ healthcare premiums, for example). Also, use your imagination and get creative to offer your employees something unique to your company. For instance, if you’re in the ice cream business, you could offer every employee a free pint of ice cream each week. Or if you provide elderly home care services, you could offer your employee’s elderly family members discounted rates.
One option to consider for offering your employees fringe benefits is a cafeteria plan, also called a section 125 plan. Allowed by the IRS, this is a written plan offering your employees a choice between cash compensation or a fringe benefit. You must allow employees the option to choose at least one taxable benefit (cash) and one qualified benefit (tax-free benefit). One of the most common qualified benefits offered by employers is a flexible spending account (FSA) used to cover medical expenses.
A cafeteria plan allows employees to make contributions toward a benefit tax-free, essentially reducing their taxable income while putting the deferred money into an account for their use—giving them more bang for their buck. These accounts allow employees to defer income to pay for healthcare with tax-free funds. It also saves your company money as any of your contributions are not taxed. To establish a cafeteria plan, you must:
- Adopt a written plan document governing the plan administration
- Make employee plan elections irrevocable
- Ensure nondiscrimination requirements are met
Cafeteria plans allow your employees to choose the benefits they want. But there are some benefits you can’t offer in a cafeteria plan, even though you could offer them separately as an additional fringe benefit.
PROS | CONS |
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Accident, life, and health benefits | Meals, lodging, working condition benefits |
Adoption assistance | Employee discounts or memberships |
Dependent care assistance | Tuition and relocation assistance |
Health savings account | Commuter benefits |
Cafeteria plans are complex. We highly recommend seeking guidance from a qualified professional to help you determine the right plan options to include.
For a detailed look at employee benefits, check out our guide to the different types of benefits.
Fringe Benefits Pros & Cons
There are many advantages of offering fringe benefits to your employees. While there can be tax implications to some, ultimately, offering more benefits and the right benefits will help you attract and retain top talent.
According to the Bureau of Labor Statistics (BLS) private employers covered 78% of medical premiums for single coverage plans and 66% for family plans. This fringe benefit is quickly becoming commonplace, so if you’re not offering it, you could be losing ground.
PROS | CONS |
---|---|
Provides extra compensation to employees besides increased salary | Many employees simply want a higher salary, not benefits |
Certain benefits increase employee health and productivity (gym membership, mental health counseling) | Creates additional expense to the employer through increased tax |
Pre-tax fringe benefits can reduce an employee’s tax liability | Some fringe benefits require administration, which increases costs |
Can you offer fringe benefits to independent contractors? While we’d normally say that you can’t offer any benefits to non-employees, you can offer independent contractors access to some fringe benefits, both those that are traditionally taxable and non-taxable (although it won’t actually be subject to employment taxes). This isn’t a common practice, however, partly because it blurs the lines between employee and independent contractor. If you do offer taxable fringe benefits to independent contractors, you must report those on Form 1099-NEC.
Bottom Line
Small businesses can up their recruitment and retention strategy by adding fringe benefits. It can help to increase an employee’s total compensation and reduce your company’s overall cost to employ. Offering fringe benefits is great, but make sure you understand the tax implications and how to attribute each benefit to all your employees.