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It’s The Little Things That Count- An overview of fringe benefits and their tax impact

At one time, most employers regarded fringe benefits as little extras that were nice but hardly necessary to attract and retain employees. Nowadays, these little things count more than ever — especially as the cost of recruiting and training staff remains high.

You may well know some of the more popular employer-provided fringe benefits available. But what you may not be familiar with is their tax impact. And there may be some benefits you’ve yet to consider.

Benefit basics

Any economic benefit an employee receives for services rendered is compensation. But under the Internal Revenue Code, noncash compensation is deemed a fringe benefit and, in some cases, may be excluded from a recipient’s income.

You may have heard these items referred to as “statutorily excluded” benefits — and they’re well worth learning more about. Why? Because they enable both the employer and the employee to come out ahead: Your company gets a deduction and usually avoids payroll taxes. Meanwhile, the benefit’s value is excluded from the worker’s income — so he or she isn’t taxed on it.

Ultimately, both parties have an incentive to shift a portion of compensation from salary to fringe benefits. Some examples of benefits treated in this manner are group-term life insurance (up to $50,000), health coverage, parking privileges, and employee discounts on company products and services.

Insurance coverage

Probably the most common fringe benefit is insurance. As long as the policy is for health, accident or certain life coverage, and doesn’t discriminate in favor of a select group of employees, its cost is deductible by the employer and not taxable to the employee.

More specifically, this favored tax treatment generally applies to group medical, dental and disability insurance — though, if a disability insurance premium isn’t taxed, any benefits received will generally be taxable. Thus, it’s usually more beneficial for employees if disability premiums are taxed so proceeds will be tax free and workers will have more after-tax income when they need it.

Also, as mentioned, employer-provided group-term life insurance coverage exceeding $50,000 does produce taxable income to covered employees. The exact amount is determined by a uniform premium table factor based on the worker’s age. Group policies paying less than $50,000 are generally nontaxable.

Retirement plans

Another common fringe benefit, and a notably well publicized one of late, is the employer-provided retirement plan. These arrangements generally fall into two categories:

1. Qualified plans. Plans that meet the requirements for specified treatment under tax and employment law fall under this heading. Included are plans such as pension, profit-sharing and 401(k) plans. Depending on the plan, funding can be through employee contributions, employer contributions or both. Employer contributions are generally currently deductible, while participants’ earnings accumulate tax deferred — that is, amounts aren’t taxed until they’re distributed.
2. Nonqualified plans. These are contractual arrangements that don’t meet the specified requirements for classification as a qualified plan. Such plans usually benefit only key employees who defer some of their compensation under the arrangement. If the plan is properly set up, the employees won’t pay income tax until they receive distributions, at which time the employer generally gets a deduction. Nonqualified plans can be extremely useful for providing an attractive compensation package to executives or other highly valued employees. Just bear in mind that these arrangements have their own complex rules — many of which were recently toughened by the American Jobs Creation Act of 2004.

Education funding

Today’s employees want more than just a paycheck; they want to grow professionally and personally. Thus, one benefit rising in popularity is education funding. There are essentially two ways to provide it:

1. An educational assistance program. Here you may offer each employee up to $5,250 of tax-free education. This may include undergraduate or graduate classes, though the participant need not actually enroll in a degree program. The education doesn’t even have to be job-related. Employers have quite a bit of flexibility. You can set eligibility requirements restricting the types of courses covered and correspondingly limit the number of eligible employees — as long as these stipulations don’t discriminate in favor of highly compensated employees. You don’t even have to fund the program every year.
2. Education as a working condition fringe. You may have already provided this if you’ve ever paid for an employee to attend a work-related conference or a continuing education class. In some instances, you can expand this tax break to cover college classes. But a worker earning a degree or certification to qualify for a new job or position will normally not qualify.

Education as a working condition fringe differs from an educational assistance program in that you don’t need a written plan, coverage can be selective and there’s no $5,250 annual cap. Restrictions on eligible course work, however, limit this to purely job-related learning.

Finishing touches

Although workers may take them for granted, other working condition fringes and de minimis benefits are also useful. These include:

• Qualified transit or parking privileges,
  
• Company parties and noncash holiday gifts,
  
• Personal use of company equipment,
  
• Meals provided to employees who work late or through their mealtimes,
  
• Tickets to entertainment or sporting events, and
  
• Discounts and no-additional-cost services, such as free hotel rooms provided to hotel staff.

Again, these offerings are a way for you to provide a tax deduction for your company and tax-free benefit to your workers. You may boost morale, too.

A driving force

Bear in mind that your company’s business structure may affect your benefit options. Partnerships and S corporations are somewhat limited in what they can offer to owners. But with or without these restrictions, fringe benefits can be a driving force in keeping your company well staffed and highly productive.

Find out how our expertise in accounting for architects and engineers can add value to your business. Email us or call us at 1 (888) 875-9770.

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