A fringe benefit is any form of payment other than money for the performance of services by employees. The IRS treats these perks as taxable fringe benefits unless they're specifically excluded by law. The good news is that the list of exclusions is long, but it doesn’t include all of the extras many workers have come to expect.
You may decide to offer your employees small perks such as meals, large ones like a retirement plan or incentives such as stock options and wellness programs. Other benefits are required by law, including Social Security taxes and workers' compensation insurance. Offering employee fringe benefits and perks can be a great way to attract and retain talent, but it can backfire if employees are caught by surprise with a fringe-benefit tax they didn’t expect.
Let’s start with the benefits the IRS excludes from a recipient’s pay. Common nontaxable employee benefits include:
- Health insurance (limits may apply to S-corp employees)
- Group term life insurance (up to $50,000)
- Tuition assistance (limits unless it’s job-related)
- Access to on-site athletic facilities
- 401(k) or other qualified retirement plan contributions
- Transportation benefits for commuters (up to $270 for commuter highway vehicles, transit passes or qualified parking)
- Child care assistance (up to $5,000)
- Adoption assistance (subject to Social Security and unemployment taxes)
- Health savings account contributions
- Employee discounts on employer property or services
A full list of exclusions can be found in IRS Publication 15-B.
While there are plenty of fringe benefits employees can enjoy tax-free, some are still taxable. Generally, that means any fringe benefit not included in the list of exclusions in IRS Publication 15-B we mentioned earlier and any exceptions to those rules. Being aware of what's taxable and what's not matters for minimizing your employees' tax liability. Whether benefits are taxable or nontaxable, you have to include them on employees' W-2 forms, said Paul T. Joseph, a certified public accountant.
7 taxable fringe benefits to watch out for
These seven fringe benefits are important to be aware of because they represent some of the most common taxable benefits, as well as ones that have undergone significant changes as a result of tax reform.
1. Personal use of a company car
Letting employees drive company vehicles for personal use can be one of the trickiest taxable fringe benefits to manage. Employees generally must pay for the personal use of a company vehicle, but determining that percentage is where it can get confusing for employers. Employers have several methods from which to calculate it, including:
- General valuation
- Lease valuation rule
- Cents-per-mile rule
A tax professional can help you determine the appropriate valuation method for your circumstances.
2. Bicycle commuting
Bicycle commuting expenses were previously treated as nontaxable employee fringe benefits. The Tax Cuts and Jobs Act removed bicycle commuting expenses from the list of qualified transportation expenses that are considered nontaxable.
That means that while you can still offer employees reimbursement for bicycle commuting expenses, it now falls under the umbrella of taxable fringe benefits.
3. Gym memberships
Offering a gym membership could be a great incentive for employees who are interested in wellness and physical fitness. But in order for a gym membership to be excluded from taxable fringe benefits, there's a catch. The gym must be located on premises you own or lease and be operated by your business. Additionally, the gym has to be primarily used by you, your employees and their spouses and/or children.
4. Business frequent flyer miles converted to cash
If you issue business credit cards to employees, frequent flyer miles earned with the card are generally considered a rebate, not taxable income. The lines get a little blurry, however, when frequent flyer miles are converted to cash. In that instance, any amounts of cash received by employees as the result of a travel miles or points conversion may be treated as taxable fringe benefits.
5. Excessive mileage reimbursement
Mileage reimbursement is something you may offer as a perk for employees, especially now that workers are unable to deduct such expenses on their taxes. The Tax Cuts and Jobs Act eliminated the deduction for job-related mileage costs that workers were able to claim when such costs were not reimbursed by their employers.
One thing to watch out for, however, is the standard mileage rate issued by the IRS. For 2020, miles are valued at 57.5 cents each. If the reimbursement rate you offer per mile exceeds this limit, the excess becomes a taxable fringe benefit.
Generally, any clothing you provide to employees is a taxable benefit, though there are a couple of exceptions. First, clothing can be excluded from taxable fringe benefits if it's a de minimis benefit, meaning it has little-to-no value. That same rule applies to other fringe benefits, such as personal use of an employer-provided cellphone. Second, clothing can be excluded from taxable fringe benefits if it's considered a working condition benefit. So if you purchase and issue uniforms for employees, that could fall under the umbrella of working condition benefits.
7. Cash awards or prizes
The IRS treats achievement awards of tangible personal property as nontaxable benefits. But if you give employees cash awards or cash equivalents, such as gift cards, then that's considered a taxable benefit. The only way to get around treating cash awards or prizes as taxable fringe benefits would be if you had control over how gift cards or gift certificates could be redeemed.