What Is a Fringe Benefit?
Fringe benefits may be defined as noncash compensation benefits provided by employers to their employees. Fringe benefits may take a variety of forms, including accident and health benefits, group-term life insurance coverage, dependent care assistance, employee discounts, meals, free parking, and free gym/club memberships. Although executives normally participate in a company's broad-based fringe benefit programs, such as group medical plans, many executives also receive fringe benefits that are available only to the executive group. Fringe benefits must be included in the employee's income unless they are specifically excluded by another provision of the Internal Revenue Code.
Some employee benefits may be subject to income tax to the employee if they discriminate in favor of executives or other highly compensated employees (HCEs). Basically, this means that if an employer wants to provide these benefits to certain executives, it needs to cover the rank-and-file employees as well. For purposes of the fringe benefit rules that include nondiscrimination provisions, the definition of an HCE is an individual who:
- Is a 5% owner at any time during either the plan year or the look-back (preceding) year, or
- Had annual compensation in excess of $125,000 (when 2019 is the look-back year). However, the employer can ignore the income test if the employee was not also in the top 20% of employees in terms of compensation for the preceding year
Employers often offer certain fringe benefits that are not subject to nondiscrimination requirements. In this way, employers may pick and choose which employees to cover.
What Are Some Common Examples of Tax-Favored Fringe Benefits That May Be Provided on a Discriminatory Basis?
A number of tax-favored fringe benefits are available on a selective or discriminatory basis. They are tax-favored in the sense that these benefits can be provided to executives (and/or to rank-and-file employees) without causing the employee to recognize income for the value of the benefit. These benefits include the following:
- Business-related working condition fringe benefits
- Convenience-related lodging and de minimis meals
- De minimis fringe benefits
- Insured health plan coverage, except self-insured medical reimbursement plans (see note in details below)
- Athletic facilities
- Qualified transportation
- Achievement awards
- Employer-provided cell phones if used primarily for business
- Retirement planning services
- Educational assistance up to certain limits
Caution: Partners and shareholders owning more than 2% of an S corporation's stock cannot exclude certain fringe benefits from income. These include contributions to accident and health plans, adoption assistance, and qualified transportation benefits.
Special tax rules apply to various types of fringe benefits; this is just an overview. For more information see IRS Publication 15-B, Employer's Tax Guide to Fringe Benefits and consult a tax advisor.
Business-Related Working Condition Fringe Benefits
A working condition fringe benefit is property or services provided to an employee so that the employee can perform his or her job. It applies to the extent the employee could deduct the cost of the property or services as a business expense or depreciation expense if he or she had paid for it. Examples of working condition fringe benefits include the use of a company car for business and certain job-related education.
Convenience-Related Meals And Lodging
The fair value of convenience-related meals or lodging furnished to an employee, his or her spouse, and his or her dependents is excluded from the employee's income. The meals must be furnished on the employer's business premises and be for the convenience of the employer. Convenience of the employer means the meal is furnished for a substantial business reason other than to provide the employee with additional pay. Cash provided for meals is not excludable unless it falls under the de minimis fringe benefit exception, or unless it's related to qualifying travel expenses. Lodging may be excluded from income if it is furnished on the employer's business premises for the convenience of the employer, and the employee is required to accept these lodgings as a condition of employment.
Note: An employer-operated eating facility which the employer owns or leases on or near its premises cannot discriminate in favor of highly compensated employees.
De Minimis Fringe Benefits
A de minimis fringe benefit is one that normally would be a taxable fringe benefit, but because the goods or services have only a nominal value, accounting for the items is unreasonable or administratively impractical. Examples include occasional theater or sporting event tickets, occasional company parties, holiday gifts with a low cash value, and certain meals. Cash and cash equivalent fringe benefits (such as gift cards) no matter the size, are never excludable as a de minimis benefit.
Insured Health Plan Coverage
Plans issued by licensed insurance companies are currently not subject to the nondiscrimination requirements. Employees may consider additional medical coverage in the form of lower deductibles, or lower coinsurance payments, for example. This treatment stands in contrast to that afforded to self-insured medical reimbursement plans, which cannot discriminate.
On-Premises Athletic Facility
A company can set up an athletic facility such as a gym or swimming pool for employees and deduct the costs to the same extent allowed for other business expenses. The use of such a facility is tax free to the employees who take advantage of it. The value of employer-paid memberships to a commercial athletic club will not qualify for this income exclusion, however.
Qualified transportation fringe benefits provided for certain employee expenses of commuting or parking are excluded from an employee's income. Qualified parking is parking provided to an employee on or near the business premises of the employer, or on or near a location from which the employee commutes to work. In 2019, up to $265 per month of qualified parking can be provided tax free to the employee. In addition, employees may be offered a choice of the qualified parking option or cash compensation for such parking.
If an employee chooses cash compensation rather than the parking, however, that amount is included in gross income. In addition, the amount of transit pass and van pooling benefits that can be excluded from an employee's income is also $265 per month for 2019.
Tip: Partners and certain S corporation owners (over 2% of stock owned) cannot exclude qualified transportation benefits from income.
What About Club Dues And Spousal Travel Costs?
Most expenses involving an executive's club dues or for a spouse's travel are nondeductible by the employer. When a company pays for these nondeductible expenses, taxable income may result for the executive. The proper tax treatment depends on whether the employer pays the expenses directly or, instead, reimburses the executive for the cost.
Expenses Paid Directly By Employer
Executives can substantiate certain club dues and travel expenses to their employers. Such amounts can be treated as business expenses even though the employer gets no deduction for the amount. The denial of a deduction to the employer does not preclude those noncash items from qualifying as working condition fringe benefits. This means that the employer's deduction for providing these benefits may be limited, but the executive is not required to recognize income.
What About a Company Car?
Company cars are often provided by employers to employees. To the extent that a company car is used for business purposes, the employee can exclude this fringe benefit from income as a working condition fringe benefit. Unreimbursed personal use of a company car (which includes commuting) is treated as a taxable fringe benefit to the employee. The fringe benefit income is reported as compensation on the employee's Form W-2.
Employees who use a company car must choose between (1) reimbursing the company for personal use to avoid income and (2) recognizing fringe benefit income for unreimbursed personal use. Recognizing the fringe benefit income results in a more favorable economic benefit and less out-of-pocket expenses for the employee.
Reimbursement Versus Fringe Benefit Income
Example(s): John uses a company car for both business and personal use — he uses it for business 40% of the time and for personal purposes 60% of the time. The fair market value of a lease of the car is $10,000. Therefore, the value of John's personal use is $6,000 (60% x $10,000). If John chooses to reimburse his company, he'll be out-of-pocket $6,000 cash.
Example(s): If, however, John chooses to incur fringe benefit income, he'll pay a total of only $2,700. John will report $6,000 worth of additional compensation income on his personal tax return. Assuming a combined 45% federal and state tax rate, the income will cost John $2,700 (45% x $6,000) in total.
Of course, employees often incur expenses while using company cars. Typical examples include gasoline and tolls.
Other Executive Perks
Certain executive fringe benefits, such as executive-owned life insurance, can be funded with employer-provided bonuses and can escape the nondiscrimination rules. Low- or no-interest loans can also be given by employers to selected executives. In addition, business expenses can be reimbursed.
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