Fringe benefits may be defined as noncash compensation benefits provided by employers to their employees. Fringe benefits may take a variety of forms, including employee discounts, company cafeteria or meal plans, free parking, and free gym/club memberships. Although executives normally participate in a company’s broad-based fringe benefit programs, such as group medical plans, many executives also receive fringe benefits that are available only to the executive group. Fringe benefits must be included in the employee’s income unless they are specifically excluded by another provision of the Internal Revenue Code.
Caution: Partners and shareholders owning more than two percent of an S corporation’s stock cannot exclude certain fringe benefits from income. The following must be included in income:
- Contributions to accident and health plans, including employer payments or reimbursement of medical expenses
- The cost of providing up to $50,000 of group-term life insurance
- The cost of meals or lodging furnished for the company’s convenience
- Qualified transportation fringes
- Achievement awards
- Adoption assistance
Nondiscrimination Rules
Some employee benefits may be subject to income tax to the employee if they discriminate in favor of executives or other highly compensated employees (HCEs). Basically, this means that if an employer wants to provide these benefits to certain executives, it needs to cover the rank-and-file employees as well.
For purposes of the fringe benefit rules that include nondiscrimination provisions, the definition of an HCE for 2013 is an individual who:
- Is a five percent owner at any time during either the plan year or the look-back (prior) year, or
- Had compensation in 2013 in excess of $115,000. However, the employer can ignore the income test if the employee was not also in the top 20 percent of employees in terms of compensation for the preceding year
Employers often offer certain fringe benefits that are not subject to nondiscrimination requirements. In this way, employers may pick and choose which employees to cover.
What Are Some Common Examples of Tax-Favored Fringe Benefits That May be Provided on a Discriminatory Basis?
A number of tax-favored fringe benefits are available on a selective or discriminatory basis. They are tax-favored in the sense that these benefits can be provided to executives (and/or to rank-and-file employees) without causing the employee to recognize income for the value of the benefit. These benefits include the following:
- Business-related working condition fringe benefits
- Convenience-related lodging and de minimis meals
- De minimis fringe benefits
- Insured health plan coverage (except self-insured medical reimbursement plans)
- Athletic facilities
- Qualified moving expense reimbursements
- Qualified transportation
- Qualified bicycle commuting
- Achievement awards
- Retirement planning services
- Tuition reimbursement
Business-Related Working Condition Fringe Benefits
A working condition fringe benefit is property or services provided to an employee so that the employee can perform his or her job. It applies to the extent the employee could deduct the cost of the property or services as a business expense or depreciation expense if he or she had paid for it. Examples of working condition fringe benefits include the use of a company car for business and certain job-related education.
Convenience-Related Meals and Lodging
The fair value of convenience-related meals or lodging furnished to an employee, his or her spouse, and his or her dependents is excluded from the employee’s income. The meals must be furnished on the employer’s business premises and be for the convenience of the employer. Convenience of the employer means the meal is furnished for a substantial business reason other than to provide the employee with additional pay. Cash provided for meals is not excludable unless it falls under the de minimis fringe benefit exception, or unless it’s related to qualifying travel expenses. Lodging may be excluded from income if it is furnished on the employer’s business premises for the convenience of the employer, and the employee is required to accept these lodgings as a condition of employment.
Tip: An employer-operated eating facility which the employer owns or leases on or near its premises cannot discriminate in favor of highly compensated employees.
De Minimis Fringe Benefits
A de minimis fringe benefit is one that normally would be a taxable fringe benefit, but because the goods or services have only a nominal value, accounting for the items is unreasonable or administratively impractical. The employee can exclude from income the value of these benefits. Examples include occasional theater or sporting event tickets, occasional cocktail parties or group meals, and occasional typing of personal letters by a company secretary. Cash and cash equivalent fringe benefits (gift card, charge card, or credit card) no matter the size, are never excludable as a de minimis benefit.
Insured Health Plan Coverage
Plans issued by licensed insurance companies are not subject to the nondiscrimination requirements. Employees may consider additional medical coverage in the form of lower deductibles, or lower coinsurance payments, for example. This treatment stands in contrast to that afforded to self-insured medical reimbursement plans, which cannot discriminate.
On-Premises Athletic Facility
A company can set up an athletic facility such as a gym or swimming pool for employees and deduct the costs to the same extent allowed for other business expenses. The use of such a facility is tax free to the employees who take advantage of it. The value of employer-paid memberships to a commercial athletic club will not qualify for this income exclusion, however.
Qualified Moving Expense Reimbursements
These are excluded from an employee’s income. A qualified moving expense reimbursement includes any amount received by an executive from an employer as a payment for, or a reimbursement of, expenses that would have been deductible as moving expenses on the executive’s tax return if directly paid or incurred by the executive.
Qualified Transportation
Qualified transportation fringe benefits provided for certain employee expenses of commuting or parking are excluded from an employee’s income. Qualified parking is parking provided to an employee on or near the business premises of the employer, or on or near a location from which the employee commutes to work. Up to $245 per month (for 2013, $240 for 2012) of qualified parking can be provided tax free to the employee. In addition, employees may be offered a choice of the qualified parking option or cash compensation for such parking. If an employee chooses cash compensation rather than the parking, however, that amount is included in gross income. In addition, the amount of transit pass and van pooling benefits that can be excluded from an employee’s income is $245 per month for 2013 ($240 for 2012).
Tip: Partners and certain S corporation owners (over two percent of stock owned) cannot exclude qualified transportation benefits from income.
Qualified Bicycle Commuting
Effective for taxable years beginning after December 31, 2008, the Emergency Economic Stabilization Act of 2008 adds a qualified bicycle commuting reimbursement fringe benefit as a qualified transportation fringe benefit. A qualified bicycle commuting reimbursement fringe benefit means, with respect to a calendar year, any employer reimbursement during the 15-month period beginning with the first day of such calendar year of an employee for reasonable expenses incurred by the employee during the calendar year for the purchase and repair of a bicycle, bicycle improvements, and bicycle storage, provided that the bicycle is regularly used for travel between the employee’s residence and place of employment. The maximum amount that can be excluded from an employee’s gross income for a calendar year on account of a bicycle commuting reimbursement fringe benefit is an amount equal to the product of $20 multiplied by the number of the employee’s qualified bicycle commuting months for the year. The $20 amount is not indexed for inflation. A qualified bicycle commuting month means with respect to an employee any month for which the employee does not receive any other qualified transportation fringe benefit and during which the employee regularly uses a bicycle for a substantial portion of travel between the employee’s residence and place of employment. Thus, no amount is credited towards an employee’s applicable annual limitation for any month in which an employee’s usage of a bicycle is infrequent or constitutes an insubstantial portion of the employee’s commute. A bicycle commuting reimbursement fringe benefit cannot be funded by an elective salary contribution on the part of an employee.
What About Club Dues and Spousal Travel Costs?
As a result of 1993 federal legislation, most expenses involving an executive’s club dues (e.g., country clubs, luncheon clubs) or for a spouse’s travel are nondeductible by the employer. When a company pays for these nondeductible expenses, taxable income may result for the executive. The proper tax treatment depends on whether the employer pays the expenses directly or, instead, reimburses the executive for the cost.
Expenses Paid Directly by Employer
Executives can substantiate certain club dues and travel expenses to their employers. Such amounts can be treated as business expenses even though the employer gets no deduction for the amount. The denial of a deduction to the employer does not preclude those noncash items from qualifying as working condition fringe benefits. This means that the employer’s deduction for providing these benefits may be limited, but the executive is not required to recognize income.
Example(s): ABC Company directly pays an executive’s $8,000 country club membership. If the executive uses the country club 60 percent of the time for business use and 40 percent of the time for personal use, then $4,800 (60 percent x $8,000) will be treated as a working condition fringe benefit and will be nontaxable to the executive. The remaining $3,200, however, will be taxable as compensation income to the executive, and this amount will be deductible by ABC Company.
Expenses Reimbursed by Employer
At present, it appears that the IRS will treat club dues and spousal costs as taxable compensation income to the executives if a company reimburses them for these costs.
What About a Company Car?
Company cars are often provided by employers to employees. To the extent that a company car is used for business purposes, the employee can exclude this fringe benefit from income as a working condition fringe benefit. Unreimbursed personal use of a company car (which includes commuting) is treated as a taxable fringe benefit to the employee. The fringe benefit income is reported as compensation on the employee’s Form W-2.
Employees who use a company car must choose between (1) reimbursing the company for personal use to avoid income and (2) recognizing fringe benefit income for unreimbursed personal use. Recognizing the fringe benefit income results in a more favorable economic benefit and less out-of-pocket expenses for the employee.
Reimbursement Versus Fringe Benefit Income Example
John uses a company car for both business and personal use—he uses it for business 40 percent of the time and for personal purposes 60 percent of the time. The fair market value of the car is $10,000. Therefore, the value of John’s personal use is $6,000 (60 percent x $10,000). If John chooses to reimburse his company, he’ll be out-of-pocket $6,000 cash. If, however, John chooses to incur fringe benefit income, he’ll pay a total of only $2,700. John will report $6,000 worth of additional compensation income on his personal tax return. Assuming a combined 45 percent federal and state tax rate, the income will cost John $2,700 (45 percent x $6,000) in total.
Of course, employees often incur expenses while using company cars. Typical examples include gasoline and tolls.
Other Executive Perks
Certain executive fringe benefits, such as executive-owned life insurance, can be funded with employer-provided bonuses and can escape the nondiscrimination rules.
Low- or no-interest loans can also be given by employers to selected executives. In addition, business expenses can be reimbursed.
If you have questions about how these perks affect your personal tax situation, contact the Experts at Henssler Financial: experts@henssler.com or 770-429-9166.
Disclosures
The following information is reprinted with permission from Forefield, a division of Broadridge Financial Solutions, Inc. This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
