What Are Fringe Benefits

Fringe Benefits. What Are They Exactly?

Employees are normally paid in cash in the form of hourly wages, a salary, piecework, or commissions, and the cash is conveyed to the employee by check, direct deposit, or in actual currency. All cash paid to employees is taxable income, subject to income tax withholding.

On the other hand, many employers endeavor to further reward their employees, attract new employees, or retain current employees, by providing additional compensation in the form of fringe benefits. What are fringe benefits, and are they subject to income taxes as well?

IRS Publication 15-B, Employer's Tax Guide to Fringe Benefits, defines a fringe benefit as “a form of pay for the performance of services.” So if an employee provides services for an employer, the employer is the provider of the fringe benefit, even if a third party provides the actual benefit. For instance, an employee may receive legal services through an attorney that is paid by the employer, but the employer is still the provider of the fringe benefit.

What fringe benefits are taxable? The truth is that all fringe benefits are taxable. The value of a fringe benefit is subject to federal income tax, Social Security tax, Medicare tax, and FUTA, and the value must be included in Boxes 1, 3 and 5 of Form W-2, and on line 3 of Form 940. However, the taxable portion of a fringe benefit may be reduced by the following amounts:

Any amount that the law excludes from compensation; and
Any amount that the recipient pays for the benefit.

So assuming that a fringe benefit may not be taxable because it isn't specifically listed anywhere in the tax law or one of the IRS publications is a mistake. The only fringe benefits that are listed in the tax laws are those that can be excluded from income, either in whole or in part.

In addition to the above factors, any or all of a fringe benefit can be excluded from taxable income only if the recipient is an employee. If the recipient of a fringe benefit is not an employee, then it is not subject to any income tax withholding, but it may have to be reported as income on one of the following information returns:

If an independent contractor is the recipient, report the value on Form 1099-MISC, in Box 7: Nonemployee compensation.
If a partner is the recipient, report the value on Schedule K-1 (Form 1065), in Box 4: Guaranteed payments.

In some cases, an individual who is normally treated as an employee, may be classified by definition as a non-employee. The definition will be tied to a specific fringe benefit. For instance, if the business is an S-Corporation, under an employer's health insurance plan an employee who owns 2% or more of the corporation's stock is not treated as an employee, so the premiums paid by the corporation for the owner's health insurance premium are taxable income to the owner.

The following is a list of employees who may not be treated as employees for certain specific benefits:

An employee who owns 2% or more of the stock in an S-Corporation [S2%].
A highly compensated employee who is one of the following: (1) an officer, (2) a shareholder who owns more than 5% of the voting power or value of all classes of the employer's stock, (3) an employee who is highly compensated based on the facts and circumstances, or (4) a spouse or dependent of a person described in (1), (2), or (3) [HCE5%].
A highly compensated employee who is one of the following: (1) one of the five highest paid officers, (2) owns more than 10% of the employer's stock, or (3) is among the highest paid 25% of all employees. [HCE10%]
A highly compensated employee who is one of the following: (1) a 5% owner at any time during the year or the preceding year, or (2) received more than $120,000 in pay for the preceding year. [HCE$120]
A key employee who is either (1) an officer having annual pay of more than $170,000, or (2) an employee who is either (a) a 5% of the business, or (b) a 1% owner of the business whose annual pay is more than $150,000. [Key]

So what fringe benefits can be excluded from income? The following article will provide a list of the most common fringe benefits that can be excluded.