June 28, 2018
Which fringe benefits are taxable and which are not? Sometimes even IRS agents have difficulty telling them apart. To help its field force, the IRS has a training manual on the tax treatment of fringe benefits. The 119-page manual is designed to help IRS personnel determine the taxability, withholding, and reporting requirements for employee fringe benefits. Of course, fringe benefits include all sorts of employer-provided benefits which are not in the form of cash. They can include items such as accident and health plans, group-term life insurance or company cars. So employees don’t have to pay for the actual cost of the benefit. If the benefit is tax-free, employees are doubly blessed.
How Fringe Benefits Are Valued
Taxable fringe benefits are valued at the “fair market value”, which is defined as “the amount a willing buyer would pay an unrelated willing seller, neither one forced to conduct the transaction and both having reasonable knowledge of the facts.” Often, the cost and FMV of a benefit are the same. The valuation amount is defined as the FMV of a taxable benefit less any amount paid by or for the employee.”
Example: An employee has a taxable fringe benefit with a fair market value of $3 per day. The employer may include the $3 per day in the employee’s wages, or the employee may pay the employer the $3 per day and no amount for the benefit is included in the employee’s wages.Special valuation rules apply for certain fringe benefits.
Consider this: If you give an employee a raise, you still must subtract federal income tax, employment tax and possibly state and local income tax from the amount paid to the employee. For 2018, the employment tax rate is 7.65% on the first $128,400 and 1.45% on wages above that amount (up from $127,200 for 2017). When earned income reaches $200,000 (or $250,000 for married couples) 1.45% rises to 2.35%, with no limit.
On the other hand, there is no such tax reduction with a tax-free fringe benefit.
Let’s assume the employee is normally in the 24% federal income tax bracket. In addition, the employee lives and works in a state where income is taxed at the 5% rate. If your company offers an employee a $10,000 raise in salary, in 2018 the employee could forfeit as much as $3,665 in tax (36.65% of $10,000). Thus, the employee walks away with only $6,335. However, if your company provides an additional tax-free fringe benefit of $10,000 instead, the employee receives the full benefit of the $10,000 increase. This also reduces the employee’s AGI for other tax purposes.
Fringe benefits can be taxable, tax-free, partially taxable, or tax-deferred. Some common tax-free fringe benefits provided by employers are the first $50,000 of group-term life insurance coverage, educational assistance plans, health care coverage and adoption assistance plans.