Employee fringe benefits are a highly effective tool in employers' efforts to recruit and retain top talent. In today's competitive job market, this approach can offer a helpful advantage, along with helping to build an employee-friendly culture that serves as a valuable recruitment and retention method.
At the same time, employers should be aware of tax implications for fringe benefits. To avoid unnecessary surprises at tax time, it's important to understand how these benefits work, what might be right for your business, which benefits are required by law, how to identify taxable benefits, and where to find professionals who can provide guidance.
What Are Fringe Benefits?
What is the definition of fringe benefits? Fringe benefits are a form of pay, often from employers to employees, and are considered compensation for services beyond the employee's normal rate of pay. These employee fringe benefits can be property, cash, cash equivalents, discounts, savings accounts, and even non-tangible benefits like experiences. Cash equivalents, such as savings bonds, can be turned into cash relatively quickly.
Generally, fringe benefits are taxable to the employee, must be included as supplemental income on the employee's W-2, and are subject to withholding and employment taxes. The IRS guides these employee benefits in a publication titled Employer's Tax Guide to Fringe Benefits For Use in 2023.
How Do Fringe Benefits Work?
As noted, fringe benefits for employees can take the form of property, services, cash, or some cash equivalent. They can also include non-tangible benefits, such as the use of a company car or flex time built into a work schedule.
Generally, an employer decides what benefits will be offered, which employees are eligible for each benefit, and how much of the benefit an employee may receive.
Legally Required Benefits
Some employers are legally required to provide certain benefits to employees based on the size of the company and the number of employees. Any benefit legally required to be offered would not be considered a fringe benefit.
Because requirements can vary from state to state, it's best to review your local and state laws or consult a benefits professional for the most accurate information on which benefits are required for your employees. Examples of the benefits required of at least some employers include:
- Workers' compensation
- Unemployment insurance
- Family and medical leave
- Health insurance
Types of Fringe Benefits and Examples
Federal labor laws and employment regulations restrict certain types of benefits. While employers have some latitude in offering fringe benefits, some benefit types will have tax implications, and other benefits are legally required for employers that fit specific criteria.
In general, fringe benefits examples include taxable benefits and nontaxable benefits.
Taxable Fringe Benefits
Some assume these perks are given and received free from taxation, but this isn't always true.
Generally, fringe benefits with significant value are considered taxable to the employee and subject to federal withholding, Social Security, and Medicare taxes. The benefit's fair market value is added to the employee's gross income and reported on the employee's W-2 form, along with any applicable taxes withheld.
Examples of taxable benefits include:
- Bonuses
- Vacation, athletic club membership, or health resort expenses
- Value of the personal use of an employer-provided vehicle
- Amounts paid to employees for moving costs in excess of actual expenses
- Business frequent-flyer miles converted to cash
- Group term life insurance provided to employees over $50,000, unless paid with post-tax employee contributions
Nontaxable Fringe Benefits
Certain fringe benefits aren't subject to federal income tax withholding and are excluded from gross income. Generally, these benefits are not subject to Social Security, Medicare, or FUTA taxes and are not reported on Form W-2.
A complete list of all nontaxable fringe benefits can be found on the IRS website, but a few examples include:
- Employer-provided spending accounts (medical flexible spending accounts, dependent care accounts, etc.)
- Payments made on behalf of employees for public transportation to and from work and parking while at work
- Up to $5,000 paid by the employer for child- or dependent-care services
- Group term life insurance up to $50,000, provided to employees
- Employee discounts
- Tuition reduction
- "De minimis" fringe benefits such as employee use of office equipment, non-cash holiday gifts, parties or picnics, and entertainment events where the value of the benefit is considered minimal
- Athletic facilities primarily used by employees, if located at the place of employment
- Retirement planning services
- Adoption assistance program
- Use of business frequent flyer miles for personal travel
- Moving expense reimbursem*nts for actual costs paid or incurred
Why Are Fringe Benefits Important?
The importance of employee benefits, in terms of their strategic value, can't be overstated. Many small business owners understand that simply meeting the legally required minimum benefits offerings for employees may not be in the company's best long-term interests. For many employees (and prospective employees), a business's benefits package can be a significant factor in deciding whether to accept a job offer. The lack of fringe benefits is also a top reason why employees may opt to leave a job.
Employers should consider offering a competitive benefits package if they want to build and retain a strong labor force.
Here's why fringe benefits are important: Small business employee benefits can be personalized to fit corporate culture and workers' needs. For many employees, finding a sustainable work-life balance that safeguards employees' financial, physical, and mental wellness is a key priority. A small business benefits package that helps them attain this goal will likely inspire loyalty and nurture positive attitudes in the workplace.
Advantages of Fringe Benefits
As noted, there are significant advantages to offering a competitive fringe benefits program to your employees. Key advantages include:
- Drawing the interest of qualified job candidates
- Enhancing workforce morale and productivity
- Helping employees who cope with health-related issues, thus reducing absences due to sickness
- Improving the rate of retention because employees value the fringe benefits an employer offers
These benefits strengthen the bond between employer and employees, with a corresponding increase in trust and loyalty.
Disadvantages of Fringe Benefits
Employers should consider certain drawbacks to fringe benefits before offering a competitive package. These disadvantages include:
- A potentially prohibitive cost, depending on the number of employees and complexity of the fringe benefits package
- Administrative expenses related to creating and maintaining a fringe benefits package
- The likelihood some employees will get more out of a benefits package than other employees
- There is a risk of legal responsibility if benefits aren't distributed in a compliant manner
These potential disadvantages can be addressed with a skilled third-party provider who is an expert in this area.
Valuing and Calculating Fringe Benefits
In general, the usefulness of a fringe benefit is based on its fair market value. Sometimes, the fair market value and the benefit cost are the same, but the fair market value may increase above the actual cost if an employer can purchase the benefit at a discount.
For taxation purposes, fair market value is typically regarded as whatever a willing buyer would pay for an item of equal value. In some cases, the IRS provides specific guidance on how to value items, which is provided in the IRS Fringe Benefits Guide.
Compare the retain cost of a similar product to establish the approximate fair value of a benefit. If, for example, employers offer an annual gym membership, the gym's regular price for adult membership represents a good valuation amount, even if an employer negotiates lower bulk pricing.
Taxing for Fringe Benefits
Tax reporting requirements can vary, depending upon who receives the benefit. Taxable fringe benefits paid by the employer are included in the employee's annual W-2 statement while taxing fringe benefits paid to independent contractors are reported on the Form 1099-NEC. Taxable fringe benefits paid to partners are reported on Schedule K-1 (Form 1065).
Ensure You Offer the Right Benefits for Your Employees
Incorporating fringe benefits into a company's hiring and retention program can be a considerable advantage in terms of sourcing and retaining your best employees. However, to use fringe benefits effectively, employers should know about various types of fringe benefits, whether they are taxable, and how to value them appropriately. Employers planning to incorporate new fringe benefits should consult the IRS' Fringe Benefit Guide for in-depth information related to federal tax laws on benefits or seek other professional advice to ensure your benefits are reported and taxed correctly.
