Whether you’ve provided standard fringe benefits like group-term life insurance or more extravagant perks like trips or company-provided vehicles, the fact is that the IRS expects taxes to be paid on most of the benefits provided to employees and contractors. With year-end approaching, you may be busy reconciling the fringe benefits you provided in 2014 in order to get them into payroll and onto W-2s. To keep you on the right side of the IRS, here are some of the basics of reporting fringe benefits.
What are fringe benefits?
The IRS defines fringe benefits as a form of pay for the performance of services. Most times, we think of fringe benefits as being provided to employees, but this definition also applies to benefits you provide to independent contractors. These include benefits you provide directly, as well as those provided by a third party. Common examples include moving expenses, employee discounts, health insurance premiums paid on behalf of two-percent S Corp shareholders, prizes and awards, business expense reimbursements and educational assistance.
When are fringe benefits taxable?
Any fringe benefit you provide is taxable and must be included in the recipient’s pay unless the law specifically excludes it. Tax treatment and exemption limits vary by type of benefit. The value of fringe benefits must be included in wages if it is more than the sum of any amounts the law excludes and the amount the recipient paid for the benefit.
How can I stay compliant?
The value of non-cash fringe benefits must be determined at least annually. For cash fringe benefits or fringe benefits that include a transfer of tangible or intangible personal property, you must report in the year the cash or property was transferred.
There is a special accounting rule that allows you to treat the value of non-cash fringe benefits provided during the last two months of the calendar year as paid in the following year, thus allowing you enough time to in November and December to calculate the benefits and add it to wages accordingly. If you choose not to use this special accounting rule, you can reasonably estimate the value of the fringe benefits and determine proper withholding and submission of payroll taxes accordingly. You would then have to true-up the value and could possibly be overpaid or underpaid on your tax deposits.
Once the taxable fringe value is determined for your employees, you’ll want to decide if applicable taxes will be your employees’ responsibility or the company’s. If the employee will be responsible, the value of the fringe would need to be added to a regular payroll period and applicable taxes withheld from your employees’ pay. If you choose to pay the employees’ share of taxes without deducting them from your employees’ pay, you can gross up the value of the fringe, therefore leaving the net pay unaffected.
Contributed by Tina Dodson, CPP, EA, in RKL’s Small Business Services Group. Tina draws on more than 16 years experience helping small business owners and their management teams meet their financial reporting and individual and corporate tax return preparation needs.