Taxable and Nontaxable Employee Benefits
As the unemployment rate falls from its 2020 high, employees are switching jobs in record numbers. The new stability in the economy means workers have more leeway to shop around for jobs that fit their lifestyles, needs and values. Now, the onus is on employers to provide an environment that makes their star team members want to stay and also attracts new talent. Part of that equation is providing a great benefits package. But if you're one of the many employers expanding their benefits, how do you pay taxes on your new programs?
In general, when an employee's wages, salary or commissions are raised, the employer must pay employment taxes. The same is true of bonuses and taxable fringe benefits.
Some benefits are not taxable to the employee, although some are subject to certain dollar limits. These benefits include:
- Health insurance up to certain dollar amounts.
- Accident and disability insurance.
- Employer contributions to qualified retirement plans, including profit-sharing plans, stock bonus plans, and money purchase plans.
- Cellphones used for business.
- Educational assistance, which is completely untaxed for job-related education and untaxed up to $5,250 for non-job-related education.
- Adoption assistance.
- Dependent care assistance up to certain dollar limits.
- Up to $50,000 group term life insurance per employee, and $2,000 for the spouse or dependent of an employee.
- Transportation benefits.
- Parking expense assistance (tax free to employees, but not deductible by employers from 2018 to 2025).
- Health savings accounts up to certain dollar limits.
- Achievement awards up to $1,600 for qualified plan awards and $400 for nonqualified awards.
- Employee discounts on the goods or services the employer sells.
The rules around the deductibility of these benefits and others can be complex and often vary based on the specific circumstances. Noncompliance with these rules can mean the benefit is taxable to the employee.
Offering even taxable benefits to employees can be beneficial, provided that the benefit is valuable enough to the employee. That is because employees pay less in tax on a benefit than they would pay for the service if they purchased it out of pocket. Taxable benefits must be included as income on the employee's W-2 or 1099.
Examples of taxable employee benefits include:
- Education assistance over the $5,250 annual limit for non-job-related education.
- Student loan repayment assistance.
- Use of a company car for personal reasons.
Employers should keep in mind that tax standing is not an issue for some benefits they may offer. For example, offering a remote, flexible or hybrid work arrangement does not have tax consequences. Benefits such as these are valuable to employees and can help attract new talent.
In addition, certain tax credits may be available to qualifying employers. For example, the Affordable Care Act allows qualifying businesses with fewer than 25 full-time-equivalent employees to deduct up to half of their contributions toward employees' health insurance premiums, or up to 35% for tax-exempt employers, for coverage offered through the Small Business Health Options Program.
This is just a summary of complex provisions. Employers should consult with their tax advisers on any benefits to make sure they're following the rules, and keep an eye out for changes.