Employers are required to tax wages paid to employees; however, not all types of employee compensation are considered wages or benefits. In fact, there are lots of exceptions and misconceptions that can lead to incorrect tax classifications, omissions, errors, and penalties.
Here's a quick reference guide to help ensure you are in perfect compliance and avoid some of the common misclassification missteps when it comes to taxable and nontaxable compensation, or fringe benefits, according to the Internal Revenue Service (IRS).
Fringe Benefits and Taxable Wages
For classification purposes, some examples of fringe benefits and taxable wages could include salaries, vacation pay, bonuses, commissions, and more:
Cash bonuses or gifts - When you award employees with cash, gift certificates, year-end bonuses, or similar items easily exchanged for cash, you must report the value of such gifts as extra salary or wages, regardless of the amount that was provided.
Non-cash prizes - If you award prizes or bonuses in the form of goods or services (e.g., a vacation trip for meeting sales goals) you must report the fair market value of the goods or services as employees' income.
Employer-provided professional services - The value of employer-provided tax preparation, accounting, legal, or brokerage services should also be reported as extra salary or wages. Don't forget that this also holds true if an employee accepts these services in exchange for reduced severance pay.
Personal use of employer-provided vehicles - If you provide a company car (or other highway motor vehicle) to your employees, the personal use of that vehicle may be taxable as a noncash fringe benefit. See IRS Publication 525 for how to determine the value of that benefit.
Fringe Benefits and Non-Taxable Wages
Many fringe benefits are not taxable and, therefore, exempt from the tax reporting requirement. Here's a partial list based on our customers' inquiries:
Diminis (minimal) gifts - If you provide employees with a product or service and the cost is so small that it would be unreasonable for you to account for it, the value need not be included in the employee’s income. Examples include holiday gifts, occasional theater or sporting event tickets, flowers, fruit, or books. There is no set dollar limit, but the IRS has ruled in at least one case that a gift over $100 must be treated as taxable income.
Achievement awards - Item of “tangible personal property” (e.g. a trophy or award plaque) that you give an employee for length of service.
The award must be given as part of a meaningful presentation and under such conditions that it does not amount to disguised compensation. Depending on the circumstances, the excludable value of the award is limited to either $400 or $1,600 or the employer’s actual cost.
Employer-provided discounted goods and services - Discounts on employer-provided goods or services normally offered to customers during the course of business may be exempt from tax.
No additional cost services - Generally, these are exempt if you provide such services to customers during the ordinary course of business, and incur no substantial additional cost in providing those services to your employee.
Lodging and meals - On your business premises are exempt if certain conditions are met (e.g., furnished for the employer’s convenience, the employee must accept lodging as a condition of employment).
Reimbursements for Educational Assistance - Employees can exclude from their income up to $5,250 of qualified employer-provided educational assistance if certain conditions are satisfied. See IRS Pub. 970 for details.
Moving expense reimbursements - Applies only to moving expenses that the employee could deduct if he or she had paid or incurred them without reimbursement. Does not apply if the employee actually deducted these expenses in a previous year. See IRS Pub. 521 for details.
Group-Term Life Insurance - You can provide up to $50,000 of group-term life insurance coverage without reporting the employer’s cost in the employee’s income; report anything over this threshold as taxable wages
Accident and health benefits - As of this writing, employer contributions to an employee’s accident or health insurance plan are nontaxable, including: Contributions to the cost of accident or health insurance, including qualified long-term care insurance
COBRA Premiums - Amounts you pay to maintain medical coverage for a current or former employee under COBRA should not be reported as taxable wages, provided the plan covered is a “qualified plan..
Frequently Asked Questions
What Happens After Classifying Employee Compensation Types as Taxable or Nontaxable?
Once you finish classifying all the different types of employee compensation as taxable or non-taxable, it's important to check your current payroll setup to ensure these compensation types line up with your investigation. Better yet, ask your cloud-based payroll solution vendor's support team to help get it done so you can get back to running your business.
If you need further help navigating taxable vs non-taxable employee compensation, contact us for support. Additionally, if you're looking for additional guidance on compliance-related topics, whether on compensation or general labor law understanding, schedule a compliance check-up and speak with one of our experts today.
