What keeps employees happy, engaged, and loyal? Salary, paid time off, health insurance, and retirement benefits are vital parts of the equation, but many employers also give their employees perks — otherwise known as fringe benefits.
Many employers and employees think of fringe benefits as freebies that don’t impact the employee’s taxable income. But that’s not always the case.
Employers don’t have to include some fringe benefits in the employee’s wages, but others they do. Leaving them out of the employee’s wages — and therefore avoiding federal income tax and payroll taxes — can be a costly error to make.
What Are Fringe Benefits?
Fringe benefits are any type of pay or perks an employee receives in addition to their salary. Examples of fringe benefits include:
- Adoption assistance programs
- Cash awards
- Child and dependent care assistance
- Commuting assistance
- Company cars
- Continuing education
- Disability insurance
- Free snacks or meals
- Flexible spending accounts
- Gym memberships
- Health, vision, and dental insurance
- Life insurance
- Moving reimbursements
- Paid time off
- Parental leave
- Retirement plans like 401(k)s or savings incentive match plan for employees individual retirement accounts
- Stock options
- Tuition reimbursement
Fringe benefits can be taxable (included in your taxable income and reported on your W-2) or nontaxable (not included in your taxable income and possibly not reported on your W-2). To avoid problems with the IRS, it’s vital to know the difference.
Taxable vs. Nontaxable Fringe Benefits
According to IRS Publication 15-B, Employer’s Tax Guide to Fringe Benefits, all fringe benefits are taxable and must be included in the employee’s taxable income unless the law specifically excludes it.
Section 2 of Publication 15-B provides a list of excludable benefits, including:
- Accident and Health Benefits. These benefits include premiums the employer pays toward health insurance and long-term care insurance. They also include payments made directly to the employee for medical expense reimbursements.
- Achievement Awards. Employers can give employees property worth up to $1,600 as an award for length of service or safety achievement. The exclusion doesn’t apply to awards of cash, gift cards, or gift certificates.
- Adoption Assistance. Employers can help employees cover up to $14,300 in adoption costs without including the benefits in the employee’s taxable income.
- Athletic Facilities. Employers who provide on-premises gyms or other athletic facilities can exclude the value of this benefit from the employee’s pay. To qualify, the facility can only be available to employees, their spouses, and dependents. The exclusion doesn’t apply if the employer sells membership or rents the facility to the general public.
- De Minimis Benefits. De minimis fringe benefits are property and services the employer provides to the employee that have so little value that it would be unreasonable or impracticable for the employer to account for them. That includes occasional use of the company’s copier, flowers, coffee and doughnuts, or occasional theater or sporting event tickets. There is no specific dollar amount that automatically makes a benefit more than de minimis. However, the IRS usually considers benefits that cost $75 or less to be de minimis. The exclusion doesn’t apply to any cash, gift cards, or gift certificates, no matter how small the amount.
- Dependent Care Assistance. These programs help employees pay for the cost of the care of a child or other dependent, allowing the employee to work. Employers can exclude up to $5,000 of dependent care benefits from the employee’s wages.
- Educational Assistance. Educational assistance programs allow an employer to fully or partially cover costs for an employee’s education, including tuition, fees, books, equipment, and supplies. Employers can exclude up to $5,250 of educational benefits from the employee’s wages each year.
- Employee Discounts. Many employers allow employees to purchase the goods and services offered to customers at a discount. Employers can exclude the value of this discount from the employee’s wages up to the following limits: 20% of the price charged to nonemployee customers for services or the business’s gross profit percentage times the price charged to nonemployee customers for merchandise and other property.
- Employee Stock Options. Typically, stock options aren’t taxable income to the employee when the employer grants them. However, the employee may have to pay tax when they exercise the option (that is, actually purchase the stock) or later sell the stock at a gain. Check out our explanation of employee stock options for more details on types of stock options and how the IRS taxes each of them.
- Employer-Provided Cellphones. If an employer provides a cellphone to an employee to be used primarily for business purposes, the phone’s value isn’t taxable income, even if the employee occasionally uses the phone for personal use. However, employers that provide cellphones to employees without a legitimate business purpose must include the phone’s value in the employee’s taxable wages.
- Group Term-Life Insurance Coverage. Employers can generally exclude up to $50,000 of group term life insurance coverage from an employee’s wages. Employers must include the cost of coverage over that limit in the employee’s taxable income.
- Health Savings Account (HSA). For 2020, employers can contribute up to $3,550 to an individual’s HSA or $7,100 to a family HSA without including it in the employee’s taxable income.
- Lodging on the Business Premises. Employers who provide lodging to an employee on their business premises (for example, a household employer who provides a room for a live-in nanny) can exclude the value of that accommodation from the employee’s wages.
- Meals. Employers don’t have to count as wages the value of meals provided to employees as long as the meals are provided on the employer’s business premises and for the employer’s convenience. This exclusion can apply to companies that provide an employee cafeteria and restaurants that allow employees to have a meal before, during, or after their shift.
- No-Additional Cost Services. This exclusion applies to employers who provide their normal services to employees without incurring any additional costs. For example, airline employees taking free flights or hotel employees taking advantage of a free room.
- Retirement Planning Services. Employers who provide a retirement plan, such as a 401(k), to employees can exclude from the employee’s wages the value of any retirement planning advice they provide.
- Transportation (Commuting) Benefits. Employers who provide transportation and commuting benefits, such as carpooling rides, transit passes or parking permits, can exclude up to $270 of benefits per month from the employees’ wages.
- Tuition Reduction. Universities and other educational organizations that provide reduced tuition to employees and their dependents can exclude the value of that reduction from the employees’ taxable income.
- Working Condition Fringe Benefits. This type of fringe benefit includes property or services that would have been deductible as a business expense if the employee had paid for it. The benefit must relate to the employer’s business, and the employer must document the business purpose of the expense with records (such as receipts). Examples of working condition fringe benefits include traveling to attend a client meeting, the cost of a business lunch or dinner, or attending professional conferences.
Employers must include the cost of any fringe benefits that do not fall within this list of exclusions in the employee’s taxable income.
How to Avoid Underreporting Your Income
Employers aren’t the only ones who can get into trouble with the IRS for improperly accounting for fringe benefits. Employees should also take notice because they’re responsible for properly reporting income each year, whether or not they receive a correct W-2 form from their employer.
The IRS can hold employers liable for payroll taxes they should have withheld on the underreported amounts. They can also hold employees responsible for the income tax owed on the underreported amounts — or charge them with tax fraud if the employee knowingly underreports their income.
There are five fringe benefits employers tend to miss when calculating employees’ tax withholding and reporting taxable income to the IRS.
- Gift Cards or Cash Equivalents. If you received a gift card, no matter how small the amount, you should report it as wages — even a $5 gift card.
- Prizes and Awards. Did you win a contest at work? If so, did you receive an award? What about an iPad as a prize in a raffle? Achievement awards aren’t taxable, but you should include other prizes and awards in your wages.
- Personal Use of Company Car. Do you use a company car for work? If you’re also allowed to use it for errands and personal trips on evenings and weekends, you should include the value of that personal use in wages.
- Moving Expenses. Before the Tax Cuts and Jobs Act of 2017, employers could provide tax-free reimbursement of moving expenses if their employee moved more than 50 miles away for their job. Moving reimbursements are now a taxable benefit.
- Expense Reimbursements Under a Nonaccountable Plan. Employers often reimburse employees for business expenses the employee pays out of their own pocket. As long as the employee and employer account for reimbursements correctly, they aren’t taxable to the employee. Under an accountable plan, the employee must provide documentation, such as a receipt or invoice, showing the nature and amount of the expense. If the employer reimburses the employee for more than the employee actually spent, the employee has to return the excess to the employer within a reasonable timeframe (usually 120 days). Expense reimbursements under a nonaccountable plan are income, and employers must include them in the employee’s wages. For example, if an employer gives an employee $100 per day for meals while traveling and the employee doesn’t have to provide receipts for meals or return any unspent funds to their employer, the employer must include that $100 per day in the employee’s wages.
While every employer has the responsibility to report wages accurately, employees are ultimately responsible for correctly reporting their income to the IRS. If you receive any of the benefits described above, ask questions.
The best place to start is with your company’s payroll department. Make sure you report the value of any taxable fringe benefits as income on your tax return, whether or not your employer correctly includes them in W-2 wages.
Even if your employer claims to report all wages properly, make sure you keep track of the benefits you believe are taxable and include that value on your tax return. Make sure you aren’t setting yourself up for any tax penalties for underreporting your income.