Ah, October — fall colors, frost on the pumpkin, Halloween — and a good time to start calculating the value of the fringe benefits that you provided to your employees this year.
Why? you might ask. Well, as you generously attempted to augment you employees’ total compensation packages through the offering of more and better fringe benefits, you may have (not so generously) forgotten to give the IRS its “fair share” and, come year end, you will have to pay up.
Specifically, the value of fringe benefits provided to your employees must be included as compensation on their Forms W-2 and you, and they, must pay all taxes due on those benefits.
You may have a few questions:
What are fringe benefits?
Although the IRS is adamant about including the value of fringe benefits in income, it never really gets around to defining the term. Why are you not surprised?
Generalizing from examples given in various publications, fringe benefits may be described as compensation (other than traditional salaries, bonuses, and commissions) provided to or for the benefit of employees in exchange for services rendered.
Which fringe benefits must be included in income?
As compensation, all fringe benefits are includable in income and are taxable (FIT, FICA, FUTA, and probably SIT and SUI, as well) unless they are specifically excluded from income by statute. The value of a fringe benefit is includable in the income of the employee performing the service for which the benefit is compensation, even though he may not be the actual recipient of the benefit. (Example: employer operated athletic facilities used by the employee’s spouse.)
Which fringe benefits may be excluded from income?
The Internal Revenue Code excludes nine types of fringe benefits from taxable income (see “State Payroll News” for state treatment):
1. No additional cost services are services, normally offered for sale by the employer to customers in the ordinary course of business, that are provided to employees for personal use at no additional cost to the employer. (Example: free standby flights provided by an airline to its employees.)
2. Qualified employee discounts are discounts: (a) on merchandise, that are not in excess of the gross profit percentage on regular price sales of the merchandise to customers, or (b) on services, that are not in excess of 20% of the regular customer price. (Example: a discount of 40% on merchandise costing a department store $50 and normally sold for $100 [50% gross profit percentage].)
3. Working condition fringe benefits are those whose costs, if borne by the employee, would be deductible as ordinary and necessary business expenses. (Examples: use of a company car or airplane for business purposes, benefits provided for employee safety, on the job training, and merchandise provided for off site product testing and evaluation.)
Cash payments do not qualify as working condition fringe benefits unless the cash is provided for use in connection with a deductible business activity, such use is verified by the employer, and cash not so used is returned to the employer.
4. De minimus fringe benefits are those whose value is so minimal that accounting for the benefits would be administratively unreasonable or impractical. (Examples: occasional personal use of copy machines, coffee and doughnuts, occasional tickets to sporting or entertainment events, and local telephone calls.)
5. Employer operated athletic facilities are those located on the employer’s premises, operated by the employer, and used primarily by current and retired employees and their spouses and dependent children.
6. Qualified meals and lodging are those provided on the employer’s premises, for the convenience of the employer, and, in the case of lodging, required as a condition of employment. (Examples: lunch provided to employees who must work during normal lunch hours because of peak business activity, housing provided to a hotel manager.)
7. Qualified tuition reimbursements are payments made, under an accountable and nondiscriminatory plan, for job related education that maintains or improves skills required for the individual’s employment or that is required as a condition of employment. Payments made for education necessary to meet minimum job requirements or to qualify the individual for a new trade or business are not excludable from income.
8. Qualified employer transportation benefits include up to $60 per month in mass transit passes or reimbursement for mass transit or vanpooling expenses, local transit fares given to employees doing occasional overtime, cab fares or similar assistance for employees working in unsafe conditions, and up to $160 per month in parking benefits.
9. Qualified moving expense reimbursements are excludable from income if: (a) the expenses would be allowed as deductions by the employee, and (b) the employee did not deduct the expenses in a prior year. Moving expenses normally deductible by an employee include the cost of moving household and personal goods and the cost of travel between the old and new residences.
Are there any limitations on the above?
Highly compensated employees may not exclude: no additional cost services, qualified employee discounts, or qualified meals and lodging from income unless those benefits are provided in a manner that does not discriminate in favor of the highly compensated employees.
May any other fringe benefits be excluded from income?
Other fringe benefits, including, but not limited to, dependent care assistance, group term life insurance, medical and health insurance, legal assistance, death benefits, and incentive stock options, may be excluded, usually subject to dollar limitations, if provided to employees under written, nondiscriminatory plans which adhere to specified formats, rules, and regulations. See IRS Publication 525, “Taxable and Nontaxable Income,” for more information.
How are fringe benefits valued?
The fair market value of the benefit (what the employee would pay to acquire the benefit in an arm’s length transaction), less any cash paid by the employee, is the amount to be included in income and upon which to withhold payroll taxes. Special valuation rules exist for company cars, flights on company aircraft, and meals provided at employer operated eating facilities.
When must I withhold taxes on fringe benefit income?
You must withhold (and pay your share) of payroll taxes at the time the benefit is “paid” to your employees. The “payment” may be treated as either regular or supplemental wages and withholding amounts calculated according to the respective rules.
You do, however, have some leeway in specifying when benefits are paid:
1. You may treat benefits as paid during any regular (up to and including annual) pay period falling no later than December 31 of the calendar year in which provided (see number 3 below for year end rules).
You do not have to use the same payment date for every benefit or for every employee. Payment dates may vary from year to year.
2. You may elect to treat a single benefit as paid on multiple dates even if the value of the benefit is received all at one time.
3. Benefits provided during November and December of a given calendar year may be treated as paid in the following calendar year. The year end election may be applied to some benefits and not to others but all employees receiving a benefit for which year end rules are selected must be treated equally.
You remain liable for the payment of taxes on benefits deemed paid to separated employees subsequent to their dates of separation.
So, sharpen your pencil. Catch up on those delayed withholdings before that final, holiday paycheck. Your employees will be much happier!
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