For small business owners, offering fringe benefits that are valuable to employees can improve job satisfaction and help them offer a competitive benefits package. There are a wide variety of fringe benefits that employers can choose to offer and some are even excluded from employees' taxable income.
What is a fringe benefit?
A fringe benefit is a form of pay for the performance of services. Almost any property or service provided by an employer to an employee as compensation for the employee's performance of services can be considered a fringe benefit. For example, fringe benefits include the following items:
- an employer-provided vehicle
- a free or discounted commercial airline flight through your frequent flyer miles
- a discount on services or property
- a ticket to a sporting event or other entertainment
- a membership in a country club or social club
Are fringe benefits taxable to the employee?
Any fringe benefit you provide is taxable and must be included in the employee’s pay unless the tax law specifically excludes it. The Internal Revenue Code may provide that a fringe benefit is taxable, nontaxable, partially taxable, or tax deferred.
Generally, taxable fringe benefits are included in an employee’s wages at their fair market value. Fair market value is the amount a willing buyer would pay an unrelated willing seller. In many cases fair market value and cost are the same. However, in some cases they will differ. The taxable amount of the fringe benefit is reduced by any amount paid for by the employee.
If you operate your business as a corporation or as a partnership, there may be personal tax implications involved if your business takes a deduction for fringe benefits provided. For example, if your corporation takes a deduction for the cost of certain fringe benefits it gives to you as an employee, you will probably have to include the value of the fringe benefits in your personal income. Depending on what tax bracket you're in, a deduction that your corporation takes could end up costing you money in the long run!
The taxation of fringe benefits is a complex topic and a full discussion is beyond the scope of this article. More information can be obtained from IRS Publication 15-B Employer’s Tax Guide to Fringe Benefits. If you are concerned with the tax consequences of fringe benefits it is also recommended that the advice of a tax professional be obtained before deciding which fringe benefits to offer.
Nontaxable fringe benefits
While you generally must treat fringe benefits as being part of your employees' taxable wages, there are certain fringe benefits that are excepted from this rule. (The complete list of nontaxable fringe benefits can be found in IRS Publication 15-B Employer’s Tax Guide to Fringe Benefits). The major advantage to offering the benefits on this list is that you can still take a business deduction for their cost even though your employees (or you, if you're an employee of your own corporation) don't have to pay tax on them.
Among the nontaxable fringe benefits that small businesses may wish to offer are the following:
- ·no-additional-cost services
- qualified employee discounts
- working condition fringe benefits
- qualified transportation fringe benefits
No-additional-cost services
A no-additional-cost services fringe benefit is a fringe benefit that arises when you provide your employees (or their spouses or dependent children) with a service that you provide to your customers or clients in your regular line of business. For example, an airline may allow its employees to fly for free when there are empty seats on a plane, or a hotel chain may allow its employees to use rooms that would otherwise be empty.
For these purposes, the term employee includes:
- an individual currently employed by you
- an individual who stopped working for you because of retirement or disability
- a surviving spouse of an individual who died while working for you or who stopped working for you because of retirement or disability
- a leased employee who has provided services to you on a substantially full-time basis for at least a year if the services are performed under your primary direction or control
- a partner who performs services for your partnership
This benefit is nontaxable to employees as long as you don't incur any substantial additional costs to provide the service to your employees. Additional costs usually include the cost of labor, materials, and supplies. Keep in mind — if additional costs are incurred, the cost of the entire service is taxable, not just the added costs.
You can’t exclude from the wages of a highly compensated employee the value of a non-additional-cost service that isn’t available to either all of your employees or a group of employees defined under a reasonable classification you set up that doesn’t favor highly compensated employees. For 2023 a highly compensated employee is, in general, either an employee who was a 5% owner, or who received more than $135,000 in pay.
Qualified employee discounts
Qualified employee discounts are fringe benefits that arise when you give employees (or their spouses and dependent children) a price reduction on property or services that you ordinarily sell to your customers or clients. However, discounts on personal property usually held for investment, such as stocks or bonds, and discounts on real property, such as buildings or land, are not qualified employee discounts.
There is a limitation on the nontaxable amount of a qualified employee discount you can provide. For merchandise or other property, the nontaxable discount doesn't include any amount that is more than your gross profit percent times the price you charge customers for the property. The gross profit percent is based on all property offered to customers, including your employees that are customers, in the ordinary course of your type of business and your experience during the tax year immediately before the tax year in which the discount is available. To calculate the gross profit percent, subtract the total cost of the property from the total sales price of the property and divide your result by the total sales price of the property.
For services, the nontaxable discount doesn't include any amount that is more than 20 percent of the price you charge customers for the service.
For these purposes, the term employee includes:
- an individual currently employed by you
- an individual who stopped working for you because of retirement or disability
- a surviving spouse of an individual who died while working for you or who stopped working for you because of retirement or disability
- a leased employee who has provided services to you on a substantially full-time basis for at least a year if the services are performed under your primary direction or control
- a partner who performs services for your partnership
The same limitation on providing an exclusion from income to highly compensated employees that applies to no-additional-cost services also applies to qualified employee discounts.
Working condition fringe benefits
The working condition fringe benefit exclusion applies to property and services you provide to an employee so that the employee can perform his or her job. It applies to the extent the cost of the property or services would be allowable as a business expense or depreciation expense deduction to the employee if he or she had paid for it.
Examples of working condition benefits include use of a company car for business, an employer-provided cell phone provided mainly for noncompensatory business purposes, and job-related educational assistance.
The kinds of items that don't qualify as nontaxable working condition fringe benefits include the following:
- expenses that an employee can deduct under sections of the tax laws other than as trade or business expenses or depreciation
- physical exams, even if they're mandatory
- cash payments you make to your employees unless you require your employee to use the money for expenses that are deductible in a specific or prearranged activity as trade, business, or depreciation expenses, you verify the that the money is used for such expenses, and the employee returns any unused money to you
- services or property offered through a Flexible Spending Arrangement (FSA)
For purposes of the working condition fringe benefit, an employee includes:
- an individual currently employed by you
- a partner who performs services for your partnership
- a director of your company
- an independent contractor who performs services for you
For educational assistance to qualify as a working condition fringe benefit, the cost of the education must be a job-related deductible expense for your employee. That is, the payment must be for education that allows the employee to maintain skills needed or advantageous on the job, but that does not qualify the employee for a new occupation.
Minimal fringe benefits
A minimal fringe benefit (often referred to as a "de minimis" fringe benefit) is any property or service that you provide to your employees that has such a small value that accounting for it would be unreasonable. These benefits are not taxable to your employees.
The following are some examples of minimal fringe benefits:
- ·occasional tickets for theatrical or sporting events
- holiday gifts, (other than cash), with a low fair market value
- coffee, doughnuts, or soft drinks
- ·occasional parties or picnics for employees and their guests
- ·occasional meal money or local transportation fare for employees working overtime (not based on hours worked), and for meals provided to enable employees to work overtime
- ·occasional personal use of a company copying machine
- group term life insurance of $2,000 or less payable on the death of an employee's spouse or dependent
Examples of fringe benefits that are not excludable from income include seasons tickets to theatrical or sports events, the commuting use of an employer-provided vehicle for more than one day a month, and membership in a private country club or athletic facility.
Qualified transportation fringe benefits
Qualified transportation fringe benefits include the following employee benefits:
- transportation in a "commuter highway vehicle" if the transportation is between an employee's home and work place. A commuter highway vehicle is any highway vehicle that seats at least six adults, not including the driver. Also, you must reasonably expect that at least 80 percent of the vehicle mileage will be for transporting employees between their homes and the work place. At least half of the vehicle's seats (not including the driver's) must be taken by your employees.
- a transit pass; that is, any pass, token, fare card, voucher, or similar item entitling a person, free of charge or at a reduced rate, to ride mass transit or in a vehicle that seats at least six adults (not including the driver), if the vehicle is operated by a person in the business of transporting persons for compensation or hire. Mass transit can be a publicly or privately operated bus, rail, or ferry service.
- qualified parking; that is, parking provided to your employees on or near your business premises. Also included is parking provided on or near the location from which your employees commute to work using mass transit, commuter highway vehicles, or carpools. It doesn't include parking on or near your employee's residence.
For these purposes, the term employee includes:
- an individual currently employed by you
- a leased employee who has provided services to you on a substantially full-time basis for at least a year if the services are performed under your primary direction or control
However, self-employed individuals (including partners, two percent shareholders in S corporations, sole proprietors, and other independent contractors) are not employees for purposes of this fringe benefit.
There are limits to the exclusion of transportation fringe benefits. You can generally exclude the value of transportation benefits only up to certain limits that are adjusted periodically. (For 2023, you can exclude up to $300 per month for combined commuter highway vehicle transportation and transit passes and up to $300 per month for qualified parking.)
At one time employers were able to deduct qualified transportation benefits. However, the Tax Cuts and Jobs Act limited or eliminated tax deductions for these benefits. In addition, at one time there was an exclusion for qualified bicycle commuting reimbursements. However, the Tax Cuts and Jobs Act suspended the exclusion of qualified bicycle commuting reimbursements from employees’ income for any tax year beginning after December 2017 and before January 1, 2026.
Employee fringe benefits can increase job satisfaction for several reasons
Employers provide fringe benefits for reasons beyond their tax advantages. These reasons include the following:
- Improved quality of life: Fringe benefits such as health insurance, retirement plans, and flexible working hours can improve employees' overall well-being and work-life balance, leading to higher job satisfaction.
- Recognition and appreciation: Offering fringe benefits shows that the employer values and appreciates their employees, creating a sense of recognition and loyalty, which contributes to higher job satisfaction.
- Reduced financial stress: Benefits like bonuses, stock options, or childcare assistance can alleviate financial burdens, reducing stress and enabling employees to focus more on their work, leading to increased job satisfaction.
- Enhanced motivation: Fringe benefits can act as motivators, inspiring employees to work harder and perform better to maintain their eligibility for such rewards, leading to a sense of achievement and satisfaction.
- Attraction and retention of talent: A competitive fringe benefits package can attract skilled professionals and help retain valuable employees, fostering a positive and content workforce.
- Positive work culture: An organization that offers attractive fringe benefits often promotes a positive work culture, reinforcing the belief that employees are valued members of the team, contributing to job satisfaction.
Overall, when employees feel supported, valued, and rewarded through fringe benefits, it creates a positive work environment that enhances their job satisfaction and leads to higher productivity and performance.