As in previous years, we have prepared the following information to assist you in determining the proper employment tax treatment of some common fringe benefits, and to help in calculating the amounts of those benefits and reporting them for tax purposes. We have also enclosed a separate detailed explanation of the calculation of the additional wages relating to the personal use of a company-owned vehicle.
A fringe benefit is another form of compensation for the performance of services. Fringe benefits are taxable to recipients unless specifically excluded by law. Taxable fringe benefits that are provided to employees are generally subject to employment taxes and are reported on Form W-2. Employers using a payroll service will need to inform the service in a timely manner of the appropriate amounts to be reported. Taxable fringe benefits provided to independent contractors are generally reported on Form 1099-MISC. Fringe benefits provided to partners in a partnership (or members in a limited liability company) are reported on Schedule K-1. Additionally, certain benefits paid to S corporation shareholders are reported on Form W-2.
A company may set up a “cafeteria plan” (including a “flexible spending arrangement”) to allow employees to choose between receiving cash or taxable benefits and receiving certain “qualified” benefits, such as accident and health benefits, adoption and dependent care assistance, and group-term life insurance. Due to favorable income tax and employment tax treatment, such a plan reduces the employer’s cost of providing qualifying benefits as well as the employees’ cost of receiving them.
Special rules apply to “highly-compensated” employees. The definition of “highly compensated” varies depending on the type of benefit.
More information can be found in IRS Publication 15-B, Employer’s Tax Guide to Fringe Benefits, which is available on the IRS website (www.irs.gov) or by calling us.
Some of the more common fringe benefits are discussed below.
COMMON TYPES OF BENEFITS
REIMBURSEMENT OF EMPLOYEE BUSINESS EXPENSES
Adequate Accounting—If an employee is reimbursed for business expenses under an arrangement that requires the employee to substantiate the expenses to the employer and to return any excess amounts received within a reasonable amount of time, the reimbursements are not taxable for income or employment tax purposes. Under such an arrangement, called an “accountable plan”, the employer is not required to report the reimbursements as wages on the employee’s Form W-2.
No Adequate Accounting—On the other hand, if a reimbursement arrangement does not require the employee to substantiate deductible business expenses, the employer must report the total reimbursement for employment tax purposes and on the employee’s Form W-2 as taxable compensation. Alternatively, if an arrangement requires substantiation, but does not require the timely return of excess reimbursements, the employer must report only the amounts paid in excess of the substantiated expenses as taxable. All taxable amounts are subject to income tax withholding, social security and Medicare taxes, and federal and state unemployment taxes. The total of the nontaxable substantiated amounts is reported in Box 12 of Form W-2 and designated “Code L”.
SICK PAY—“Sick pay” and disability payments to an employee, whether paid by the employer or by an insurance company, must generally be reported for employment tax purposes like regular wages and included on the employee's Form W-2. An insurance company paying benefits may at times complete a separate Form W-2 for the employee showing the amounts paid, but it will generally not complete a separate Form 941 or Form W-3. It would be advisable to call your insurance carrier in advance to verify how it handles payment of benefits, tax withholding and remittances, and tax reporting. If your carrier does not report and remit the appropriate taxes, it is your responsibility. Refer to the instructions for Forms W-2 and W-3 and also see Section 6 of IRS Publication 15-A, Employer’s Supplemental Tax Guide, to determine the specific reporting and remittance requirements in your situation. If you use a payroll service, you should let the service know in a timely manner that your insurance carrier will be sending information that is required to be included in the reports the payroll service prepares. Generally, the last day you should call your payroll service with information on sick and disability pay and other fringe benefits (e.g., bonus payments, personal usage of company vehicles, etc.) is the same day you call in your last payroll for the year.
FRINGE BENEFITS FOR S CORPORATION SHAREHOLDERS
If an S corporation provides certain fringe benefits to a “2% shareholder”, the corporation is required to include the value of those benefits in the shareholder’s Form W-2 as additional wages. (A “2% shareholder” is an individual who directly or indirectly owns more than 2% of the S corporation’s stock. An individual is considered to indirectly own stock that is owned by his or her spouse, children, grandchildren and parents.) The following are some of the more common fringe benefits that are subject to this requirement:
- Group-term life insurance
- Accident and health insurance
- Medical reimbursement plans
- Meals and lodging furnished for the convenience of the employer
Generally, these fringe benefits are not only taxable to a 2% shareholder for income tax purposes, but are also subject to social security and Medicare taxes. However, special rules may apply to specific benefits. For example, payments for accident and health plans which cover a class of employees in addition to the 2% shareholders are not subject to social security and Medicare taxes. In contrast, payments for group-term life insurance, while subject to social security and Medicare taxes, are not subject to income tax withholding. IRS Publication 15-B, Employer’s Tax Guide to Fringe Benefits, provides more detailed guidance and should be consulted with regard to the treatment of specific benefits.
Moving expenses that are reimbursed by an employer to an employee (or paid directly by the employer for the benefit of the employee) constitute taxable income that must be reported on Form W-2, unless the expenses would have been deductible to the employee if he or she had incurred them directly without any reimbursement. Deductible moving expenses must be incurred in connection with a move that satisfies certain criteria as to the distance involved and the subsequent period of time during which the employee works at the new location. The only deductible moving expenses are those for 1) the transportation and storage of household goods and personal effects, and 2) travel and lodging costs (excluding meals) during the actual move.
Any other moving expenses paid by the employer must be reported for employment tax purposes and included in the employee’s taxable income in the year paid. Such expenses would include costs related to the sale of an old residence and the purchase of a new one, house hunting trips, living quarters near the new job, and meal expenses incurred during the move. Employers can use federal Form 4782 to provide employees with a detailed breakdown of reimbursements. (Do not file this form with the Internal Revenue Service.) For more information, see IRS Publication 521, Moving Expenses.
The first $5,250 of amounts paid during the calendar year under an employer’s Section 127 program for an employee’s qualified educational expenses is exempt compensation for federal income tax, social security and Medicare tax, and federal unemployment tax purposes. Graduate courses qualify if the program specifically includes graduate education. Any assistance in excess of the annual limit, or any amount whatsoever paid in the absence of a formal program, is treated as taxable compensation, unless the employee would have been able to deduct the expense as an employee business expense if he or she had paid it directly.
DEPENDENT CARE ASSISTANCE
You can exclude up to $5,000 per employee ($2,500 if married filing separate returns) of the value of qualifying dependent care benefits that you provide or reimburse to an employee for dependent care, if you reasonably believe the employee can exclude the benefits from his or her gross income. Report the total amount of benefits in Box 10 of Form W-2.
DE MINIMIS BENEFITS
A de minimis benefit is a fringe benefit that has so little value that it would be unreasonable or administratively impracticable to account for it. Cash, no matter how little, is never excludable except for occasional meal money or transportation fare. Examples of de minimis fringe benefits can be found in IRS Publication 15-B, Employer’s Tax Guide to Fringe Benefits, and include the following:
- Occasional personal use of a company copying machine
- Holiday gifts (other than cash) with a low fair market value
- Occasional parties or picnics for employees and their guests
- Occasional tickets for entertainment or sporting events
- Occasional typing of personal letters by a company secretary
While the above discussion is not exhaustive, we hope the information provided will prove helpful to you. If you would like to discuss in greater detail how the fringe benefit rules impact your business, or if you have any other questions, please feel free to contact any of the professionals at our firm and we will be happy to further assist you.
Richard "Woj" Wojciechowski is a partner based out of our Buffalo, NY office.