Payroll Blog

Payroll Training, Tips, and News

What Are Fringe Benefits?

As a business owner, you want to offer an attractive compensation package to the people you hire. Compensation goes beyond a worker’s salary. It includes additional small business employee benefits, known as fringe benefits. What are fringe benefits?

What are fringe benefits?

Fringe benefits are benefits in addition to an employee’s wages, like a company car, health insurance, or life insurance coverage. Any benefit you offer employees in exchange for their services (not including salary) is a fringe benefit.

Offer competitive employee benefits to attract job hunters. One study found that employee benefits were very important to 25.2% of job seekers, moderately important to 31.2%, and somewhat important to 33.8%. Only 9.8% said benefits weren’t important. But, benefits can end up costing you, like if the cost of the benefits rises annually.

There are quite a few different types of fringe benefits to offer employees. Generally speaking, fringe benefits are taxable. But, there are some fringe benefit options that are nontaxable.

What Are Fringe Benefits?

Fringe benefits for non-employees

Fringe benefits aren’t only for your employees. You can also offer fringe benefits to independent contractors. Independent contractors are workers you hire for a specific job. Unlike your employees, you do not include independent contractors on your payroll or take out taxes. However, you still pay them for the work they do in regular wages and even fringe benefits.

Business partners can also receive fringe benefits. Fringe benefits to independent contractors and partners are not taxed. But, you should report the benefit:

  • Independent contractor: Use Form 1099-MISC, Miscellaneous Income
    Partner: Use Schedule K-1 (Form 1065), Partner’s Share of Income, Deductions, Credits, etc.

Taxable fringe benefits

As with wages, most fringe benefits are subject to federal income taxes: FICA and FUTA. Unless the IRS explicitly says a fringe benefit is nontaxable, you will need to withhold taxes from fringe benefits in order to correctly deposit and report taxes.

Some taxable fringe benefits include cash bonus pay, paid personal time off, and use of business vehicles (if used outside of business).

You must determine the value of the employee fringe benefits by January 31 of the year after you give them to your employees.

For federal income tax withholding, you can either add the value of the fringe benefits to the employee’s regular wages, or you can withhold at the fringe benefit tax rate of 22% (the same rate for supplemental pay). Withhold FICA tax (Social Security and Medicare taxes) on the fringe benefits added to the employee’s wages.

Since FUTA taxes are paid by the employer and not the employee, you will use the employee’s total compensation to determine your FUTA liability.

Nontaxable fringe benefits

Some fringe benefits are not part of a worker’s taxable compensation. That means the benefits might not be subject to federal income tax withholding, FICA, and FUTA tax. In most cases, they are not included on the employee’s Form W-2.

List of fringe benefits for employees

The following list of fringe benefits is subject to exclusion rules:

  • Accident and health benefits
  • Achievement awards
  • Adoption assistance (only exempt from federal income tax)
  • Athletic facilities
  • De minimis (minimal) benefits
  • Dependent care assistance
  • Educational assistance program
  • Employee discounts
  • Employee stock options
  • Employer-provided cell phones
  • Group-term life insurance coverage
  • Health savings accounts (HSAs)
  • Lodging on business premises
  • Meals
  • Moving expense reimbursements
  • No-additional-cost services
  • Retirement planning services
  • Transportation (commuting) benefits
  • Tuition reduction
  • Working condition benefits

Be aware that some fringe benefits are only nontaxable in certain situations. Some taxes could apply. For example, group-term life insurance coverage is only exempt from FICA tax up to the cost of $50,000.

For more information on exemption, consult the IRS.

Fringe benefit statement

You can provide your employees with an annual fringe benefit statement to show them their total compensation (regular wages + fringe benefits).

For example, you might break down the cost of each fringe benefit and find that the total fringe benefit value is $14,000. Then, you can add that to their yearly salary:

What Are Fringe Benefits?

Providing a fringe benefit statement shows your employees how much they are really receiving from your business.

Section 125 cafeteria plan

A cafeteria plan allows your employees to choose the benefits they want. The benefits are given as pre-tax deductions, meaning they reduce the employee’s taxable income, which could lessen their tax liability.

When you establish a Section 125 cafeteria plan, you must let your employees choose between taxable and nontaxable benefits. The qualifying benefit comes from the list of excludable (from taxes) fringe benefits as well as flexible spending accounts (FSAs). Some of the nontaxable fringe benefits are not allowed in a cafeteria plan.

The following benefits can be included in a cafeteria plan:

  • Accident and health benefits (not Archer medical savings accounts)
  • Adoption assistance
  • Dependent care assistance
  • Group-term life insurance coverage
  • Health savings accounts (HSAs)

These benefits cannot be included in a cafeteria plan:

  • Archer medical savings accounts
  • Athletic facilities
  • De minimis (minimal) benefits
  • Educational assistance
  • Employee discounts
  • Employer-provided cell phones
  • Lodging on business premises
  • Meals
  • Moving expense reimbursements
  • No-additional-cost services
  • Retirement planning services
  • Transportation (commuting) benefits
  • Tuition reduction
  • Working condition benefits

Let’s say you decide to establish a cafeteria plan at your business. You give your employees the option between receiving cash benefits or a health savings account (HSA). Your employee chooses to have an HSA and contribute $100 per pay period. Their contributions to this account are taken out of their wages before taxes, lowering their taxable income and reducing their tax liability.

To ensure cafeteria plans don’t favor highly compensated or key employees, you need to include the value of taxable benefits in their wages and conduct discrimination testing. For more information on cafeteria plans, consult the IRS.

Simple cafeteria plan

If you employed an average of 100 or fewer employees during either of the two previous years, you can establish a simple cafeteria plan. If you’re a new business owner, you are eligible if you expect to only employ an average of 100 or fewer employees in the current year.

A simple cafeteria plan acts just like a cafeteria plan: employees can choose the benefit(s) they want to receive. But for simple cafeteria plans, you must contribute benefits on behalf of each qualifying employee.

With simple cafeteria plans, you do not need to worry about the plan favoring IRS highly compensated employees or key employees. Consult the IRS for contribution requirement rules.

Need help withholding taxes from employee fringe benefits? Patriot Software’s online payroll services will calculate deductions on your behalf. And, we offer free setup and support to get you started. Try it for free today!

Comments are closed.

Try our payroll software in a free, no-obligation

30-day trial!

Easily run payroll in just 3 easy steps.

Start My Free Trial

Or you can EXPLORE A DEMO ACCOUNT!