If your business offers perks such as company cars, reimbursements, employee gifts or other benefits, you may be creating tax consequences without realizing it. A fringe benefit can be taxable compensation even when no cash changes hands.
The General Rule
The basic federal rule is straightforward: a fringe benefit provided for services is generally taxable unless the Internal Revenue Code specifically provides an exclusion.
If the benefit is taxable, its value generally must be included in the recipient's compensation and may be subject to income tax withholding, Social Security, Medicare and other employment-tax reporting requirements.
1. Health and Accident Benefits
Employer-provided accident and health benefits can generally be excluded from an employee's taxable income when the applicable requirements are met.
However, special rules apply to certain owners. For example, more-than-2% shareholders of S corporations do not receive identical treatment to ordinary employees for several fringe-benefit exclusions.
This is one reason owner benefits should be reviewed separately instead of simply running them through payroll in the same way as every other employee.
2. Company Vehicles
A company vehicle does not automatically mean that all vehicle use is tax free.
Business use can generally qualify as a working-condition fringe benefit. Personal use, including many commuting situations, is generally taxable to the employee.
Employers therefore need records supporting:
- Total mileage.
- Business mileage.
- Dates and destinations.
- Business purpose.
- Personal use of the vehicle.
Without adequate documentation, a business may have difficulty supporting the amount excluded from the employee's wages.
3. Employee Reimbursements
Business reimbursements should generally be made under an accountable plan when possible.
Under a properly administered accountable plan, employees substantiate business expenses and return excess reimbursements. Qualifying reimbursements generally do not have to be treated as taxable wages.
Simply giving an employee a flat monthly allowance without requiring documentation can create a very different tax result.
4. Gift Cards Are Usually Taxable
One of the most common mistakes occurs with employee gift cards.
Cash and cash equivalents, including most gift cards and gift certificates, generally cannot qualify as tax-free de minimis fringe benefits merely because the dollar amount is small.
The dollar amount alone does not convert a gift card into a tax-free de minimis benefit.
5. What Can Qualify as a De Minimis Benefit?
Certain property or services may be excluded when the value is so small, and the benefit is provided so infrequently, that accounting for it would be unreasonable or administratively impracticable.
Examples can include:
- Occasional employee snacks or refreshments.
- Occasional parties or picnics.
- Flowers, fruit or similar low-value items for special circumstances.
- Occasional tickets to entertainment events.
- Certain occasional transportation benefits.
Frequency matters. Something that may qualify when provided occasionally can become taxable if it becomes routine.
6. Employer-Provided Cell Phones
When an employer provides a cell phone primarily for substantial, noncompensatory business reasons, the business use can generally qualify as a working-condition fringe benefit.
Incidental personal use of that employer-provided phone may also qualify for exclusion under the de minimis rules.
The key is that the phone is being provided because the business needs the employee to have it, not simply as additional compensation.
7. Educational Assistance
A qualifying employer educational assistance program may provide tax-favored educational benefits subject to applicable limits and requirements.
The plan should be structured and documented correctly rather than simply reimbursing educational expenses informally through payroll or accounts payable.
8. Achievement Awards
Certain qualifying employee achievement awards consisting of tangible personal property can receive favorable tax treatment when statutory requirements are met.
Cash, ordinary gift cards, vacations, meals and many other items do not qualify merely because they are described by the employer as an award.
9. Working-Condition Benefits
A working-condition benefit generally involves property or services that the employee could have deducted as a business expense if the employee had paid for the item personally, subject to the applicable rules.
Examples may include business use of an employer vehicle, qualifying job-related education and an employer-provided cell phone used for substantial business purposes.
Why Businesses Get This Wrong
Many fringe-benefit problems arise because the bookkeeping and payroll systems are disconnected.
A vehicle may be recorded correctly as a company asset but its personal use never reaches payroll. An employee reimbursement may be booked as an expense but nobody determines whether the employee substantiated the expense. Gift cards may be coded to "employee appreciation" but never added to taxable compensation.
Correct accounting does not automatically mean correct payroll reporting.
Year-End Fringe Benefit Review
Before completing year-end payroll, businesses should review noncash compensation and employee benefits to identify items that may need to be added to Form W-2 wages.
Company vehicles, shareholder health insurance, employee gifts, allowances and other noncash benefits deserve particular attention.
Reference materials include IRS Publication 15-B and Publication 525.
Fringe-benefit treatment varies depending on the employee, ownership structure and facts. This article provides general educational information.
Abotteen & Co. provides business tax, accounting, payroll-related tax planning and advisory services.