Paper Trails

How do taxes for benefits work?

One of the more effective practices businesses use to hire and retain employees is offering a strong benefits package. As with any aspect of payroll, once a business begins offering fringe benefits, tax compliance issues arise. Let’s take a look at how taxes work on employee benefits.

What are fringe benefits?

Fringe benefits are any additional benefits or perks that a company provides to its’ employees other than the employee’s pay. Examples of fringe benefits include:

  • Health Insurance
  • Workers Compensation Insurance
  • Retirement Plans
  • Family Medical Leave
  • Health Savings Accounts (HSA)
  • Bonuses
  • Vacation Time
  • Tuition Reimbursement
  • Travel/Mileage Reimbursement
  • Commuter Benefits
  • Meal Compensation

There are other types of fringe benefits, but these are the most common examples. A key takeaway is that fringe benefits are not just the small and uncommon perks, they can be important benefits to offer your employees, such as health insurance and retirement.

Are fringe benefits taxable?

Certain fringe benefits are considered taxable while others are not. Unless a benefit falls under certain IRS guidelines as a non-taxable benefit, employers must withhold payroll taxes on fringe benefits. The fair market value of the benefit is added to the employee’s gross income. Additionally, these benefits are reported on the employee’s W-2 form along with the taxes withheld. Taxes that these benefits are subject to include:

  • Federal income tax
  • State income tax (where applicable)
  • Social security tax
  • Medicare tax
  • Federal Unemployment tax (FUTA)

So, which benefits are considered taxable? Examples of benefits that need to be taxed include:

  • Bonuses
  • Moving expenses paid above actual incurred expenses
  • Vacation expenses
  • Mileage reimbursement over the IRS threshold**
  • Personal use of employer-provided vehicle
  • Group term life insurance above $50,000

**For the mileage reimbursement benefit, the IRS has recently announced an increase in the standard mileage rate for 2023. Taxpayers may use the standard mileage rates to calculate the deductible costs of operating an automobile for business purposes. The new rate is 65.5 cents per mile. Let’s look at an example:

Company A reimburses their employees 70 cents per mile as a fringe benefit. Since the IRS rate is 65.5 cents per mile, the remaining 4.5 cents per mile must be added to an employee’s wages as taxable income. Say Employee B earns $1,000 per pay period and also drives 1,000 miles per pay period. 4.5 cents per mile x 1,000 miles = $45. $45 is added to Employee B’s wages of $1,000 and the total wages, $1,045, are taxed.

Which benefits are not taxed?

There are common benefits that do fall under IRS guidelines as non-taxable. These benefits do not get included in an employee’s gross pay and are not subject to income, FICA, or FUTA taxes.

Examples of non-taxable benefits include:

  • Accident and health benefits
  • Achievement awards
  • Educational assistance
  • Employee discounts
  • Employee stock options
  • Employer-provided cell phones
  • HSAs
  • Meals
  • Retirement planning services
  • Commuter benefits

**In order for certain benefits, like health insurance, to be considered a non-taxable benefit, a business must have a Section 125 Plan in place.

What to do as an employer?

As an employer, it is extremely important to know which fringe benefits are taxable and which are not in order to maintain tax compliance. Once your business has decided which benefits to offer and have written policies in your employee handbook, it is time to set up tax withholdings for the benefits that are taxable. Be sure to have proper employee income tax and FICA tax withholdings configured as well as the employer portion of FICA and FUTA taxes. Using an automated payroll software and working with a trusted payroll vendor will help. Contact us to ensure compliance for your business!