If you and/or your spouse is employed, the salary, bonus, and any other pay you receive from your employer is income on which you must pay tax. These taxes consist of federal income tax, your employee's share of Social Security and Medicare taxes, and, in most states, state income tax.
Wouldn't it be great if employees could avoid paying taxes on at least part of their pay? Well guess what, they can.
There is one big exception to the rule that you have to pay tax on anything your employer gives you as payment for your services: You don't pay any taxes on the value of certain tax qualified fringe benefits your employer provides. These fringe benefits can include such things as health insurance, medical expense reimbursements, dental insurance, education assistance, and day care assistance.
When we say tax free, we mean it: Tax qualified benefits are totally free of federal and state income tax, and Social Security and Medicare taxes. These tax savings can make employee fringe benefits so attractive that in many cases you'd be better off forgoing part of your salary to obtain them.
Of course, you won't be better off if you contribute part of your salary to obtain an employee benefit you don't really want or need. But there are plenty of benefits that most people do want, probably including you.
Only certain types of employee fringe benefits are "tax qualified" and receive tax-free treatment. Employees must pay tax on the fair market value of any benefits they receive that are not tax qualified—for example, a company car they use for personal driving.
Tax-free employee fringe benefits include:
- Health benefits. Health benefits are by far the single most important tax qualified employee fringe benefit. Health benefits include providing employees with health, dental, and vision insurance, and paying for uninsured health-related expenses.
- Long-term care insurance. This insurance covers expenses such as the cost of nursing home care. Premiums paid for such insurance are not taxable. However, benefits received under the insurance may be partly taxable if they exceed limits set by the IRS.
- Group term life insurance. A company may provide up to $50,000 in group term life insurance to each employee tax free. If an employee is given more than $50,000 in coverage, the employee must pay tax on the excess amount. However, this tax is paid at very favorable rates.
- Disability insurance. If an employer pays disability insurance premiums for an employee (and the employee is the beneficiary), the premiums are excluded from the employee's income. However, the employee must pay income tax on any disability benefits received under the policy. There is an important exception, however: Disability payments for the loss of a bodily function or limb are tax free.
- Educational assistance. Employers may pay employees up to $5,250 tax free each year for educational expenses such as tuition, fees, and books.
- Dependent care assistance. Up to $5,000 in dependent care assistance may be provided to an employee tax free ($10,500 for 2021). For example, the company could help pay for day care for an employee's child. However, working parents may also be able to obtain a tax credit for child and dependent care. Unfortunately, you can either take the credit or the employee benefit, not both. Which is better? The one that saves you the most taxes, which depends on your overall childcare expenses, your household income, and tax filing status.
- Transportation benefits. Employers may also pay up to $270 per month for employee parking, or up to $255 per month for vanpool transportation or mass transit passes for those employees who don't drive to work. Although such benefits remain tax free to the employees, as a result of the Tax Cuts and Jobs Act ("TCJA"), employers are not allowed to deduct the cost during 2018 through 2025. The TCJA also disallows employer deductions for paying for employees' commuting transportation—for example, hiring a car service—unless such transportation is necessary for the employee's safety.
- Working condition fringe benefits. Working condition fringes are anything your employer provides or pays for that you need to do your job—for example, local and long distance travel for business, business-related meals and entertainment, professional publications, and company cars used for business driving.
- Other fringe benefits. Other tax-free employee fringe benefits include employee stock options, employee discounts (up to 20% off), meals provided for the employer's convenience (not deductible by the employer after 2025), adoption assistance, achievement awards (not including cash, gift cards, vacations, meals, lodging, theater or sporting tickets, stocks, or bonds), and retirement planning help, employee gyms, and free services provided to employees. Other de minimis (minimal) benefits can also be provided. These are things that cost very little like occasional parties or picnics for employees, and occasional tickets for entertainment or sporting events.
However, as a result of the Tax Cuts and Jobs Act enacted by Congress the array of tax-free fringes that employers can provide employees is not quite as generous as it used to be. In the past, employees who moved over 50 miles for their current job (not a new job) could receive tax-free reimbursement from their employer for their moving expenses. The TCJA eliminated this tax-free fringe benefit for 2018 through 2025.