A fringe benefit is a form of pay, for the performance of services. For example, an employer provides an employee with a fringe benefit when you allow the employee to use a business vehicle to commute to and from work. Other examples of fringe benefits include accident & health benefits, dependent care benefits, employee discounts, employee stock options, meals, moving expense reimbursements, etc.
• Performance of services — A person who performs services for your business does not have to be your employee. A person may perform services for you as an independent contractor, partner, or director.
• Provider of benefit — You are the provider of a fringe benefit if it is provided for services performed for you. You are the provider of a fringe benefit even if your client or customer provides the benefit to your employee for services the employee performs for you. For example, you are the provider of a fringe benefit for day care even if the day care is provided by a third party.
• Recipient of benefit — The person who performs services for you is the recipient of a fringe benefit provided for those services. That person may be the recipient even if the benefit is provided to someone who did not perform services for you. For example, your employee may be the recipient of a fringe benefit you provide to a member of the employee’s family.
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. Any benefit not excluded under the rules is taxable. In addition, there are specific rules for a 2% shareholder of an S Corporation.
- Taxable fringe benefits are generally included in an employee’s wages in the year the benefit is received (Code Sec. 451(a)). Taxable fringe benefits (but not nontaxable benefits) are reported as W-2 wages for an employee, or as a Form 1099-MISC payment for an independent contractor.
- Taxable benefits to partners are treated as guaranteed payments, reported on the partner’s Schedule K-1, Line 4 as a guaranteed payment and as net self-employment income (on Line 14, using Code A) (Instructions to Form 1065 and Form 1065 Schedule K-1). Self-employed persons may deduct a portion of their health and accident insurance costs in arriving at adjusted gross income. This deduction is limited to the person’s self-employment income.
I. Accident & Health Benefits, Life Insurance – Special Rule for 2% Shareholders
“2-percent shareholder” means any person who owns (or is considered as owning within the meaning of section 318) on any day during the taxable year of the S corporation more than 2 percent of the outstanding stock of such corporation or stock possessing more than 2 percent of the total combined voting power of all stock of such corporation.
2% shareholders in an S corporation rules- Because you cannot treat a 2% shareholder of an S corporation as an employee for this exclusion, you must include the value of accident or health benefits you provide to the employee in the employee’s wages subject to federal income tax withholding. However, you can exclude the value of these benefits (other than payments for specific injuries or illnesses) from the employee’s wages subject to social security, Medicare, and FUTA taxes. The deduction cannot exceed the shareholder’s reported wage or salary income from the S corporation for the year.
- Announcement 92-16 clarifies the treatment of accident and health insurance premiums paid by S corporations on behalf of 2% shareholders – It states that any accident and health payments made under a plan to benefit employees are exempt from FICA tax, pursuant to Section 3121(a)
- Shareholder-employee reports the payment as gross income but is able to claim a page 1 deduction which essentially cancels out the gross income
- Corporation must own the policy and pay the premiums thereon. Thus the premiums appear as part of the compensation on the shareholder employee’s W-2 , and the W-2 wages are the earned income for purposes of the medical insurance deduction. However, there are states that do not permit a group health insurance plan if there is only one participant in the plan. If the shareholder purchases his or her own plan, it is not provided by the corporation and is not subject to Section 162(l). If the corporation does not provide the benefit, the shareholder employee is not subject to Section 1372, and the rules or Section 1372 do not apply. Applicability of Section 1372 is necessary for Section 162(l) to permit the deduction. Therefore the shareholder is not entitled to the above AGI health insurance deduction. (See Sec 1372 & Sec 162 (1) for further details – 2% shareholder gets same treatment as a partner in a partnership receiving income and taking above the line deduction, except 2% shareholder’s wages are treated as earned income).
In late 2007 the IRS issued Notice 2008-1, which states the criteria for a single member (and multiple member) health insurance plan to qualify for the IRC §162(l) deduction. A plan providing medical care coverage for the 2-percent shareholder-employee in an S corporation is established by the S corporation if:
1. The S corporation makes the premium payments for the accident and health insurance policy covering the 2-percent shareholder employee (and his or her spouse or dependents, if applicable) in the current taxable year; or
2. The 2-percent shareholder makes the premium payments and furnishes proof of premium payment to the S corporation and then the S corporation reimburses the 2-percent shareholder-employee for the premium payments in the current taxable year. If the accident and health insurance premiums are not paid or reimbursed by the S corporation and included in the 2-percent shareholder-employee’s gross income, a plan providing medical care coverage for the 2-percent shareholder-employee is not established by the S corporation and the 2-percent shareholder employee in an S corporation is not allowed the deduction under §162(l).
II. Personal use of vehicles, aircrafts
Employer Provided Vehicles — The fair market value of personal use (as opposed to business use) of an employer-provided vehicle is includable in the gross income of the employee as a taxable fringe benefit, and the cost is deductible by the employer. The taxable amount is the fair market value based on the facts and circumstances, unless an employer elects to use any of the following three valuation methods:
1. automobile lease valuation method
2. the vehicle cents-per-mile valuation method
3. the commuting valuation method ( Reg. §1.61-21)
Flights on employer-provided aircraft — Under the general valuation rules, if your flight on an employer provided piloted aircraft is primarily personal and you control the use of the aircraft for the flight, the value is the amount it would cost to charter the flight from a third party. If there is more than one employee on the flight, the cost to charter the aircraft must be divided among those employees. The division must be based on all the facts, including which employee or employees control the use of the aircraft.
III. Cafeteria Plans
Cafeteria plans are commonly used because employees are ordinarily taxed on the maximum amount of taxable compensation they could elect to receive. If, however, an employee benefits plan qualifies as a cafeteria plan, participants are taxed only on the taxable benefits they do elect to receive. If a plan fails to qualify as a cafeteria plan, the participants are taxed on the maximum amount of taxable benefits they could have elected to receive under the plan whether or not they actually elect to receive those benefits. Employers can deduct the cost of cafeteria plan contributions. A cafeteria plan is a written, employer-sponsored plan allowing employees to choose among cash and qualified benefits. A cafeteria plan can allow employees to choose between two or more of the following benefits:
• paid vacation days;
• health or accident insurance
• COBRA continuation coverage
• accidental death and dismemberment insurance
• disability coverage
• group-term life insurance
• dependent care assistance
• adoption assistance
• 401(k) contributions
• Health Savings Account contributions.
In order to qualify as a cafeteria plan, the plan must offer at least one taxable benefit and at least one nontaxable benefit.
Normally, an employee who is given a choice between receiving a taxable benefit (such as cash or paid vacation days) and a non-taxable fringe benefit is required to include the value of the taxable benefit in income, even if the employee chooses to receive the non-taxable benefit instead.