An employee "fringe benefit" is a form of pay other than money for the performance of services by employees. Any fringe benefit provided to an employee is taxable income for that person unless the tax law specifically excludes it from taxation. Taxable fringe benefits must be included as income on the employee's W-2 and are subject to withholding.
Fortunately, there is a long list of fringe benefits that are tax-free and need not be included in the recipients' compensation. Tax-free employee fringe benefits include:
- health insurance (up to certain dollar amounts)
- accident insurance
- Health Savings Accounts
- dependent care assistance
- educational assistance
- group term life insurance coverage—limits apply based on the policy value
- qualified employee benefits plans, including profit-sharing plans, stock bonus plans, and money purchase plans
- employee stock options
- lodging on your business premises
- moving expense reimbursements
- achievement awards
- commuting benefits
- employee discounts on the goods or services the employer sells
- supplemental unemployment benefits
- de minims (low-cost) fringe benefits such as low-value birthday or holiday gifts, event tickets, traditional awards (such as a retirement gift), other special occasion gifts, and coffee and soft drinks
- cafeteria plans that allow employees to choose among two or more benefits consisting of cash and qualified benefits, and
- working condition fringe benefits--that is, property and services provided to an employee so that the employee can perform his or her job.
A detailed discussion of all the rules applicable to these fringe benefits is contained in IRS Publication 15-B, Employer’s Tax Guide to Fringe Benefits. Any benefit provided to an employee that does not comply with these rules is taxable income for that employee. For example, meals given to an employee who is required to be away from home overnight for rest are a tax-free fringe benefit. But non-overnight meals do not comply with this rule and are therefore taxable.
Here are some of the more common fringe benefits provided to employees that are taxable:
Excessive mileage reimbursements: Payments to an employee for business-related driving in his or her own car that exceed the IRS standard mileage rate are taxable income.
Moving expenses. Reimbursement of expenses for employee moves of less than 50 miles are taxable.
Clothing. Clothing given to employees that is suitable for street wear is a taxable fringe benefit.
Excessive education reimbursements. Payments for educational assistance that is not job related or that exceed the allowable IRS exclusion are taxable.
Awards and Prizes. Cash awards are taxable unless given to charity. Non-cash awards are taxable unless nominal in value or given to charity.
Expense reimbursements without adequate accounting. An employee must provide an adequate accounting for any expense reimbursement or it will be taxable income.
Working condition fringes. A working condition fringe benefit is tax-free to an employee to the extent the employee would be able to deduct the cost of the property or services as a business or depreciation expense if he or she had paid for it. If the employee uses the benefit 100% for work, it is tax-free. But the value of any personal use of a working condition fringe benefit must be included in the employee’s compensation, and he or she must pay tax on it. The employee must meet any documentation requirements that apply to the deduction.
Example: Sam, the owner of a small architecture firm, leases a computer and gives it to his employee Paul so that he can perform design work at home. If Paul uses the computer 100% for his work, it is tax-free to him. But if he uses it only 50% of the time for work and 50% of the time for personal purposes, he would have to pay income tax on 50% of its value.
The value of the personal use is determined according to the benefit’s fair market value.
Example: It cost Sam $200 a month to rent the computer he gave Paul. If Paul uses the computer 50% of the time for work and 50% of the time for nondeductible personal uses, he would have to add $100 per month to his taxable compensation.
One of the most common working condition fringe benefits is a company car. If an employee uses a company car part of the time for personal driving, the value of the personal use must be included in the employee’s income. The employer determines how to value the use of a car, and there are several methods that may be used. The most common is for the employer to report a percentage of the car’s annual lease value as determined by IRS tables. For a detailed discussion of these valuation rules, refer to IRS Publication 15-B.
To learn more about business tax and deductions, see Nolo's Small Business Tax & Deductions center.