Tax Treatment of Fringe Benefits

The term “fringe benefit” refers to any benefit provided to an employee that is in addition to money. All benefits provided to an employee are taxable unless the law specifically excludes or defers tax on the benefit. Thus, a fringe benefit can be taxable, tax-deferred, or excluded from taxation.

The personal use of an employer-provided vehicle is an example of a taxable fringe benefit. An employer contribution to a qualified retirement plan on behalf of the employee is an example of a tax-deferred fringe benefit. Employer-provided health insurance for an employee is an example of a tax-free fringe benefit.

Business Owner

A small business owner in a corporate setting may be both the owner and an employee of his or her business. By taking advantage of excludable fringe benefits, the owner receives a double benefit. First, the cost of the benefit is deductible by the business. Second, the cost of the benefit is tax free to the employee-owner.

Nondiscrimination Rules for Fringe Benefits

Nondiscrimination rules are designed to prevent business owners from offering tax-favored fringe benefits to themselves but not their employees. In general, if fringe benefits are offered to all employees, then all
employees, including the top paid employees, receive tax-favored treatment on employee benefits. However, if a plan favors highly-compensated employees or key employees, the value of the benefit must be included in their taxable wages. The terms highly-compensated employees and key employees can mean different things depending on the applicable plan. Special restrictions apply for fringe benefits for sole proprietors, partners, certain LLC members, and S corporation shareholders. Consult your tax advisor if you are a business owner considering providing fringe benefits to yourself and your employees.

Employer-Provided Vehicles

If an employer provides an employee with a company-owned vehicle, the employer must include the value of any personal use in the employee’s Form W-2 as other compensation. Social Security and Medicare tax must be withheld. Federal income tax withholding is optional if the employee was notified and the value of the benefit is included in boxes 1, 3, 5, and 14 of Form W-2. The employer has several options on how to calculate the value of the benefit.

  • General valuation,
  • Annual lease value method,
  • Cents-per-mile method, and
  • Commuting value method.

Employer-Provided Cell Phones

The value of an employer-provided cell phone, provided primarily for noncompensatory business reasons, is
excludable from an employee’s income.

Noncompensatory Business Purposes

An employer needs substantial business reasons for providing the cell phone. Examples include:

  • Need to contact the employee at all times for work-related emergencies,
  • Requirement that the employee be available to speak with clients at all times when the employee is away from the office, and
  • Need to speak with clients located in other time zones at times outside of the employee’s normal workday.

The value of the cell phones provided to promote goodwill, boost morale, or attract prospective employees cannot be excluded from an employee’s wage.

Dependent Care Assistance

Up to $5,000 ($2,500 for Married Filing Separately filing status) of dependent care benefits provided under a dependent care assistance program is excludable from taxable wages. Although these benefits are reported in box 10 of the employee’s Form W-2, they are not taxable if used for providing qualified care. The benefits are reported with the tax return on Form 2441, Child and Dependent Care Expenses. If benefits received are more than the amount that can be excluded, the excess is included as taxable wages on Form 1040. If an employee receives dependent care benefits, it is still possible for the employee to claim a tax credit for additional expenses.

Other Fringe Benefits

Additional fringe benefits for employees may include:

  • Use of on-premises athletic facilities.
  • Low-value or de minimis benefits.
  • Employee discounts.
  • Up to $50,000 group-term life insurance.
  • Health benefits.
  • Certain business-related meals and lodging.
  • Moving expenses.*
  • Up to $5,250 of educational assistance including student loan payments.
  • Transportation benefits.
  • Certain benefits provided as a working condition

*For tax years 2018 through 2025, the qualified moving expense deduction is allowed only for members of the Armed Forces (or their spouses or dependents) on active duty that move because of a military order and incident to a permanent change of station.

Cafeteria Plans

A cafeteria plan allows employees to choose between receiving taxable compensation or a qualified benefit for which the law provides an exclusion from taxation. If the employee chooses the benefit, it is excluded from taxation. Cafeteria plans are sometimes referred to as “flex plans,” “flexible spending arrangements,” or “FSAs.”

Nondiscrimation Rules Apply to the Following:

Cafeteria Plans for Highly-Compensated Employees

  • Officer of corporation
  • More than 5% shareholder
  • Highly-compensated employee based on facts and circumstances
  • Spouse or dependent of above

Cafeteria Plans for Key Employees

  • Officer having annual pay of more than: $185,000 in 2020 – $180,000 in 2019 – $175,000 in 2018
  • 5% owner-employee
  • 1%owner employee with annual pay more than $150,000

Self-Insured Medical Reimbursement Plans for Highly-Compensated Employees

  • One of five highest paid officers
  • Employee owning more than 10% of employer’s stock
  • Highest paid 25% of all employees

Adoption Assistance, Dependent Care Assistance, Educational Assistance, Employee Discounts, Health Savings Accounts, Meals Provided at Employer-Operated Eating Facilities, No-Additional-Cost Service for Highly-Compensated Employees:

  • 5% owner-employee at any time during year or preceding year
  • Employee with annual pay for preceding year more than: $130,000 in 2020 – $125,000 in 2019 – $175,000 in 2018 (this test can be ignored if employee was not also in top 20% of employees).

Group-Term Life Insurance for Key Employees

  • Officer having annual pay of more than: $185,000 in 2020 – $180,000 in 2019 – $175,000 in 2018
  • 5% owner-employee
  • 1% owner-employee with annual pay more than $150,000

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