Taxation of Employer Fringe Benefits and IRS Treatment

By | December 5, 2015

A fringe benefit is a form of payment for the performance of services. Employers provide fringe benefits to workers of all types, including employees, independent contractors, partners, and directors. Any fringe benefit a business provides to a worker in connection with the performance of services is taxable and must be included in the worker’s income unless the law specifically excludes it or the recipient pays for the benefit.



Reporting Fringe Benefits on Form 941

Fringe benefits provided to employees that the law does not specifically exclude from income, are subject to employment taxes, and the employer must report the benefits on the employee’s Form W-2, wage and tax statement, and Form 941. If the fringe benefit is provided in connection with the performance of services by a worker who is not an employee, the provider may have to report the benefit on Form 1099 Miscellaneous for independent contractors, or on Schedule K-1, Form 1065 for partners.


How to determine the amount or value of fringe benefits?

How to determine the amount or value of fringe benefits that must be included as wages for employment tax purposes. A business must generally report the fair market value of the benefit provided to a worker, less any amount paid for the benefit by the worker as income and wages on the worker’s form W-2. However, there are some special valuation rules for fringe benefits that a business may elect to use if they meet the requirements for use of those specific rules.

What is the Fair Market Value of Fringe Benefits?

The fair market value of a fringe benefit is the amount an employee would have to pay a third party in an arm’s length transaction to buy or lease the benefit. This amount is based on all the related facts and circumstances. Note that neither the amount the employee considers to be the value of the fringe benefit nor the cost the employer incurs to provide the benefit determines the fair market value. There are special rules for determining the value of some benefits. Those benefits are meals provided at the employer-operated eating facility, use of aircraft, use of automobiles. More information about these benefits is in Publication 15B, Employer’s Tax Guide to Fringe Benefits.


When should an employer withhold on these fringe benefits?

Generally an employer must determine the actual value of non-cash fringe benefits no later than January 31st of the year after the year in which the benefit was received. Before January 31st, the business may reasonably estimate the value of the fringe benefits for purposes of withholding and depositing on time. That is the general rule, but this can get complicated, so please check out the valuations and special timing rules in Publication 15B.


Valuation of Fringe Benefits

Let’s complete this discussion on valuation and withholding by pointing out that if an employer chooses to pay an employee’s social security and Medicare taxes on taxable fringe benefits without deducting them from his or her pay, the employer must include the amount of those tax payments in the employee’s income. Also, if the employee terminates his employment and the employer has unpaid and uncollected taxes for non-cash benefits, the employer is still liable for those taxes. Finally, an employer must determine the actual value of fringe benefits provided during a calendar year by January 31st of the following year. The employer must report the actual value on Form 941 or Form 944, Employers Annual Federal Tax Return, and Form W-2.


Fringe benefits and cafeteria plans.

We cannot examine cafeteria plans in depth, but I can provide an overview. A cafeteria plan including a flexible spending arrangement, is a written plan that allows employees to choose between receiving cash or taxable benefits instead of certain qualified benefits for which the law provides an exclusion from wages. If an employee chooses to receive a qualified benefit under a cafeteria plan, the fact that the employee could have received cash or taxable benefits instead will not make the qualified benefit taxable. However, if a cafeteria plan favors highly-compensated or key employees, a business must include in their wages the value of the taxable benefit they could have selected. Definitions of highly-compensated and key employees are in the cafeteria plan section of Publication 15B. Instances where benefits can be includable in an income and subject to employment taxes.


Benefits excludable from income

Can you talk a little bit about benefits excludable from income? Fringe benefit exclusion rules exclude all or part of the value of certain benefits from the recipient’s pay. These excluded benefits are not subject to federal income tax withholding. Also, in most cases, they are not subject to social security, Medicare, or federal unemployment tax and are not reported on Form W-2. Exclusion rules apply to a host of benefits under various code sections. Some of these benefits include accident and health benefits, adoption assistance, dependent care assistance, group term life insurance, no-additional-cost services, transportation benefits, bus pass, metro card, subject to specific limitations.


Common excludable fringe benefits

A few other common excludable benefits are employee discounts, health savings accounts, HSAs, working condition benefits. There is more information about these and other fringe benefits in Publication 15B, Employer’s Tax Guide to Fringe Benefits. There are several exemptions, so make sure to check Publication 15B and the IRS website for more information. A and B are not correct, because some benefits will be includable in income and some exempt for both employees and independent contractors. And I think it is pretty obvious that D is not a correct choice, since we’ve already explained that the benefits are includable in income unless exempted by law. That concludes our discussion on fringe benefits.