CARL WATTS & ASSOCIATES

June 10, 2013



The IRS defines fringe benefits as a form of pay that includes property, services, cash or cash equivalent, in addition to stated pay for the performance of services.

The term fringe benefits itself came into common usage after the Second World War, but the concept actually goes back centuries.


Today, in an effort to retain valuable workers and attract new talent, companies may offer quite a wide range of relatively cost-effective fringe benefits to their employees. In fact, a 2010 survey of human resource professionals shows that the value of fringe benefits amounts to about 50% of payroll in American companies.


An amount equal to about 19% of a firm's payroll goes to fund government-mandated benefits such as Social Security and Unemployment Compensation, but companies spend a nearly equal amount on voluntary benefits such as health and life insurance. Pay for time not worked (like vacation, sick and personal leave days) accounts for an amount equal to about 11% of the total payroll at most American companies.


You don’t have to be an employee to be the recipient of fringe benefits - you may perform services as an independent contractor, partner or director, or you may receive benefits as a member of an employee’s family.

Technically, the IRS specifies that any fringe benefit is taxable and must be included in the recipient's pay unless the law specifically excludes it.

Practically, fringe benefits may be:

  • Completely taxable, such as bonuses which are always completely taxable, or gift cards. The employer is required by law to assess the dollar value of a particular benefit and report it as part of the employee’s income.

  • Non-taxable (such as medical care premiums paid by an employer),

  • Partially taxable (benefits with specific dollar exclusions such as the public transportation subsidy), or


  • Tax-deferred (retirement benefits under a 401(k) plan).


In addition, certain fringe benefits may be excludable as de minimis due to the small value and the impracticality of accounting for such amounts. An example of a de minimis benefit might be employer-provided coffee or an occasional ticket to a sporting event. However, cash will never qualify as a de minimis fringe benefit.


If taxable, the value of fringe benefits that you receive as an employee are included in box 1 of your Form W-2, Wage and Tax Statement, and may also be reported separately in box 12 with the appropriate code.


If you are an independent contractor, the value of the fringe benefits is not subject to employment taxes and would be included in your Form 1099-MISC, and if you are a partner, in Schedule K-1 (Form 1065).

Here are some of the most common fringe benefits and their tax treatment:


Cafeteria Plans


A cafeteria plan, including a flexible spending arrangement, is a written plan that allows an employee to choose between receiving cash or taxable benefits instead of certain qualified benefits for which the law provides an exclusion from wages. If an employee chooses to receive a qualified benefit under the plan, the fact that the employee could have received cash or a taxable benefit instead will not make the qualified benefit taxable.

For plan years beginning after December 31, 2012, a cafeteria plan may not allow an employee to request salary reduction contributions for a health FSA in excess of $2,500.


If the plan is not maintained under a collective bargaining agreement and it favors highly compensated employees and/or key employees as to eligibility to participate, contributions, or benefits, the value of taxable benefits they could have selected must be included in their wages.



Fringe benefits that are excluded from federal income tax and, in most cases, from social security, Medicare, or federal unemployment tax include:


  • Accident and health benefits - these are exempt, except for long-term care benefits provided through a flexible spending or similar arrangement.


  • Achievement awards are exempt1 up to $1,600 for qualified plan awards ($400 for nonqualified awards).


  • Adoption assistance is exempt from federal income tax but subject to social security and Medicare.


  • Athletic facilities are exempt if substantially all use during the calendar year is by employees, their spouses, and their dependent children and the facility is operated by the employer on premises owned or leased by the employer.

  • De minimis (minimal) benefits.

  • Dependent care assistance is exempt up to certain limits ($5,000 for married filing jointly and $2,500 for married employee filing separate returns).

  • Educational assistance is exempt up to $5,250 of benefits each year.

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  • Employee discounts are excluded up to the following limits: for a discount on services, 20% of the price nonemployee customers are charged for the service; for a discount on merchandise or other property, the gross profit percentage times the price charged on nonemployee customers for the property. Excludible discounts apply to current employees, former employees, widows and widowers of former employees, leased employees, and partners who perform services for a partnership.
  • Employee stock options have more complicated rules; generally exemption rules include remuneration resulting from the exercise, after October 22, 2004, of an incentive stock option or under an employee stock purchase plan option, or from any disposition of stock acquired by exercising such an option.


  • Employer-provided cell phones are exempt if provided primarily for noncompensatory business purposes.


  • Group-term life insurance coverage is exempt from federal income tax. Exemption from social security and Medicare is up $50,000 of coverage. (Special rules apply to former employees.)


  • Health savings accounts are exempt for qualified individuals up to the HSA contribution limits.


  • Lodging on the business premises is exempt if furnished for the employer’s convenience as a condition of employment.


  • Clothing used exclusively on the job. Clothing given to employees that is suitable for street wear is a taxable fringe benefit.

  • Meals are exempt if furnished for the employer’s convenience or if de minimis.


  • Moving expense reimbursements, except for reimbursement of expenses for employee moves of less than 50 miles, which are taxable.

  • No-additional-cost services. Generally, no-additional-cost services are excess capacity services, such as airline, bus, or train tickets; hotel rooms; or telephone services provided free or at a reduced price to employees working in those lines of business.

  • Retirement planning services. In addition to employer plan advice and information, the services provided may include general advice and information on retirement. However, the exclusion does not apply to services for tax preparation, accounting, legal, or brokerage services.

  • Transportation (commuting) benefits are exempt up to certain limits if for rides in a commuter highway vehicle and/or transit passes ($245), qualified parking ($245), or qualified bicycle commuting reimbursement ($20). Payments to an employee for business-related driving in his or her own car that exceed the IRS standard mileage rate are taxable income.


  • Tuition reduction is exempt if for undergraduate education (or graduate education if the employee performs teaching or research activities). Payments for educational assistance that is not job related or that exceed the allowable IRS exclusion are taxable.

  • Working condition benefits, meaning property and services provided to an employee so that the employee can perform his or her job. A working condition fringe benefit is tax-free to an employee to the extent the employee would be able to deduct the cost of the property or services as a business or depreciation expense if he or she had paid for it. If the employee uses the benefit 100% for work, it is tax-free. But the value of any personal use of a working condition fringe benefit must be included in the employee’s compensation, and he or she must pay tax on it. The employee must meet any documentation requirements that apply to the deduction. Outplacement services qualify for exclusion from income as a working condition benefit.

  • Awards and prizes. Cash awards are taxable unless given to charity. Non-cash awards are taxable unless nominal in value or given to charity.

Some companies are quite creative in the fringe benefits department. Here are some examples:

  • 2 weeks paid time off to work at a non-profit organization;
  • Deliver locally grown organic treats to workers' desks;
  • Encourage employees to spend up to 10% of their work time on projects of their own devising;
  • Provide laundry pickup and return;
  • Offer interest-free loans to employees to purchase computers.

Whether you are the provider or the beneficiary of fringe benefits, it is important that you know which benefits are taxable and which are excludable (you can check the IRS guide). Make sure to keep close track of all of your fringe benefits throughout the year so you can enjoy all possible tax exclusions and avoid trouble with the IRS.