Providing Employee Fringe Benefits Can Increase Job Satisfaction and Performance

Fringe benefits are property and services whose benefit to employees often outweighs the cost to the employer. Generally, fringe benefits are part of your employees' taxable wages, but there are certain fringe benefits that are excepted from this rule and you can still take a business deduction for their cost. Nontaxable fringe benefits include no-additional-cost services, qualified employee discounts, working condition fringe benefits, very minimal fringe benefits and qualified transportation fringe benefits.

For small business owners, offering fringe benefits that are valuable to employees can improve job satisfaction and help them offer a competitive benefits package. There are a wide variety of fringe benefits that employers can choose to offer and some are even specifically excluded from employees' taxable income.

What exactly is a "fringe" benefit? Almost any property or service provided by an employer to an employee as compensation for the employee's performance of services is considered a fringe benefit. For example, fringe benefits include the following items:

an employer-provided vehicle
a free or discounted commercial airline flight through your frequent flyer miles
a discount on services or property
a ticket to a sporting event or other entertainment
a membership in a country club or social club

In general, your employees must pay payroll taxes on the value of any fringe benefits you provide in their income unless the fringe benefits are specifically excluded from income under the federal income tax laws.

For example, if you let your sales representatives use a company car for personal purposes, the value of this noncash fringe benefit must be included in the sales representative's wages as part of his compensation.

Except for certain fringe benefits subject to special valuation rules, a general valuation rule is used to figure out how much employees include in their income.

If you have no employees per se, but you do business as a corporation or as a partnership, you may be able to take advantage of some of the deductions available for the fringe benefits that your business provides.

If you operate your business as a corporation or as a partnership, there may be personal tax implications involved if your business takes a deduction for fringe benefits provided. For example, if your corporation takes a deduction for the cost of certain fringe benefits it gives to you as an employee, you will probably have to include the value of the fringe benefits in your personal income. Depending on what tax bracket you're in, a deduction that your corporation takes could end up costing you money in the long run!

Nontaxable Fringe Benefits

While you generally must treat fringe benefits as being part of your employees' taxable wages, there are certain fringe benefits that are excepted from this rule. The major advantage to offering the benefits on this list is that you can still take a business deduction for their cost even though your employees (or you, if you're an employee of your own corporation) don't have to pay tax on them. The nontaxable fringe benefits are the following:

no-additional-cost services
qualified employee discounts
working condition fringe benefits
very minimal fringe benefits
qualified transportation fringe benefits

No-Additional-Cost Services This fringe benefit arises when you provide your employees (or their spouses or dependent children) with a service that you provide to your customers or clients in your regular line of business. For example, an airline may allow its employees to fly for free when there are empty seats on a plane, or a hotel chain may allow its employees to use rooms that would otherwise be empty.

For these purposes, the term employee includes:

an individual currently employed by you
an individual who stopped working for you because of retirement or disability
a surviving spouse of an individual who died while working for you or who stopped working for you because of retirement or disability
a partner who performs services for your partnership

This benefit is nontaxable to employees as long as you don't incur any substantial additional costs to provide the service to your employees. Additional costs usually include the cost of labor, materials, and supplies. Keep in mind — if additional costs are incurred, the cost of the entire service is taxable, not just the added costs.

Limits Apply to Qualified Employee Discounts

Qualified employee discounts are fringe benefits that arise when you give employees (or their spouses and dependent children) a price reduction on property or services that you ordinarily sell to your customers or clients. However, discounts on personal property usually held for investment, such as stocks or bonds, and discounts on real property, such as buildings or land, are not qualified employee discounts.

There is a limitation on the nontaxable amount of a qualified employee discount you can provide. For property, the nontaxable discount doesn't include any amount that is more than your gross profit percent times the price you charge customers for the property. The gross profit percent is based on all property offered to customers, including your employees that are customers, in the ordinary course of your type of business and your experience during the tax year immediately before the tax year in which the discount is available. To calculate the gross profit percent, subtract the total cost of the property from the total sales price of the property and divide your result by the total sales price of the property.

For services, the nontaxable discount doesn't include any amount that is more than 20 percent of the price you charge customers for the service.

Assume all the merchandise in your store cost you about $156,000. The total sales price of all the merchandise is $210,000. Recently you gave your employee a $350 discount on merchandise that has a sales price of $1,250. Now you must determine whether any of that discount has to be included in the employee's wages for tax purposes.

Based on the gross profit percentage calculation, you should take the sales price of all your merchandise ($210,000) and subtract what this merchandise cost you ($156,000). Now, take this number ($210,000 - $156,000 = $54,000) and divide it by the sales price ($54,000/$210,000 = .257). This gives you a gross profit percentage of 25.7% (.257 x 100).

Now you take the 25.7 percent and multiply it by the normal sales price of the merchandise you sold at a discount to your employee ($1,250 x 25.7%=$321.25). Subtract this number from the discount you gave your employee ($350-$321.25 = $28.75). Since the discount you gave your employee is greater than that provided by the gross profit percentage calculation, you're going to have to include $28.75 as a taxable discount in the employee's wages.

For these purposes, the term employee includes:

an individual currently employed by you
an individual who stopped working for you because of retirement or disability
a surviving spouse of an individual who died while working for you or who stopped working for you because of retirement or disability
a partner who performs services for your partnership

It's important to note that highly compensated employees can't exclude the value of no-additional-cost services and qualified employee discounts from their income unless the benefit is available to all employees or a group of employees defined under a reasonable classification that doesn't discriminate in favor of highly compensated employees.

A highly compensated employee is an employee who satisfies either of the following:

was a 5 percent owner of the employer at any time during the current year or the preceding year, or
received more than $115,000 in compensation from the employer during the preceding year (employers may use an additional qualification requiring employees to be in the top 20% of employees when ranked by compensation). The $115,000 threshold is for 2013 and may be indexed for inflation.

If a benefit is discriminatory, the entire cost of the benefit (not just the discriminatory part) must be included in the income of highly compensated employees. It's clear that the IRS will allow either all or nothing when they offer you a break on paying tax on these fringe benefits — all your company's employees must benefit equally or you will receive no benefit.

As owner and president of Luxury Looks For Less, you are the only company employee entitled to a 50 percent discount on all merchandise. The rest of your employees are entitled to a 25 percent discount on merchandise purchases. Because of the 25 percent disparity in discount rates (50 percent - 25 percent), the IRS will not let you exclude any portion of the discount from your salary because it is discriminatory toward your employees who are not owners. Your employees, on the other hand will still continue to enjoy the 25 percent discount and it will not be treated as compensation to them.

Working Condition and Very Minimal Fringe Benefits You Can Provide

You don't have to include the value of property or services you provide to your employees as part of their taxable compensation, if they could deduct the cost of the property or services as a trade or business expense if they had paid for them. The value is considered a working condition fringe benefit. Very minimal fringe benefits are excluded from taxable compensation as well.

Working Condition Fringe Benefits

Job training, educational assistance, meals that are provided for the convenience of the employer, and employer-provided vehicles used for business are among the common working condition fringe benefits for most small businesses. Vehicles that employees are not likely to use more than minimally for personal purposes because of their design (for example, a delivery truck with seating for the driver only, or tractors and other special purpose farm vehicles), also qualify as working condition fringe benefits for employees that use them.

What kind of property doesn't qualify? The kinds of items that don't qualify as nontaxable working condition fringe benefits include the following:

expenses that an employee can deduct under sections of the tax laws other than as trade or business expenses or depreciation
physical exams, even if they're mandatory for all or just some of your employees
cash payments you make to your employees unless you require your employee to use the money for expenses that are deductible in a specific or prearranged activity as trade, business, or depreciation expenses, you verify the that the money is used for such expenses, and the employee returns any unused money to you
services or property offered through a Flexible Spending Arrangement (FSA)

For purposes of the working condition fringe benefit, an employee includes:

an individual currently employed by you
a partner who performs services for your partnership
a director of your company
an independent contractor who performs services for you

Special rules for educational assistance. For educational assistance to qualify as a working condition fringe benefit, the cost of the education must be a job-related deductible expense for your employee. That is, the payment must be for education that allows the employee to maintain skills needed or advantageous on the job, but that does not qualify the employee for a new occupation.

If the education does not bear the required relationship to the job, it may still be excluded from taxable income if it meets the requirement of a special law provision. This provision says that an employee can exclude from taxable income up to $5,250 of employer-provided educational assistance annually if the program meets certain nondiscrimination requirements.

Very Minimal Fringe Benefits

A minimal fringe benefit (often referred to as a "de minimis" fringe benefit) is any property or service that you provide to your employees that has such a small value that accounting for it would be unreasonable. These benefits are not taxable to your employees.

If you decide to provide some minimal benefits to employees, be careful not to provide them too often. If you're frequently providing minimal fringe benefits to your employees, the IRS may require that the benefits be included in employees' compensation because, in addition to the actual value of the benefit, the IRS considers frequency a key consideration in determining if a benefit is minimal.

The following are some examples of minimal fringe benefits:

occasional tickets for entertainment or sporting events
holiday gifts, (other than cash), with a low fair market value
coffee, doughnuts, or soft drinks
occasional parties or picnics for employees and their guests
occasional meal money or local transportation fare for employees working overtime (not based on hours worked), and for meals provided to enable employees to work overtime
occasional use of a company copying machine
group term life insurance of $2,000 or less payable on the death of an employee's spouse or dependent

Cash is not excluded as a minimal fringe benefit, no matter how small the amount. (The only exception is the occasional meal money or local transportation fare listed above.)

Qualified Transportation Fringe Benefits Can Be Excluded From Income

Qualified transportation fringe benefits, which are not taxable to the employees but are deductible by you, are the following employee benefits:

transportation in a "commuter highway vehicle" (a van pool) if the transportation is between an employee's home and work place. A commuter highway vehicle is any highway vehicle that seats at least six adults, including the driver. Also, you must reasonably expect that at least 80 percent of the vehicle mileage will be for transporting employees between their homes and the work place. At least half of the vehicle's seats (not including the driver's) must be taken by your employees.
a transit pass; that is, any pass, token, fare card, voucher, or similar item entitling a person, free of charge or at a reduced rate, to ride mass transit or in a vehicle that seats at least six adults (not including the driver), if the vehicle is operated by a person in the business of transporting persons for compensation or hire. Mass transit can be a publicly or privately operated bus, rail, or ferry service.
qualified parking; that is, parking provided to your employees on or near your business premises. Also included is parking provided on or near the location from which your employees commute to work using mass transit, commuter highway vehicles (van pools), or carpools. It doesn't include parking on or near your employee's residence.

For qualified transportation fringe benefit purposes, an employee is any common-law employee or other statutory employee; for example, officers of corporations are included. However, self-employed individuals (including partners, two percent shareholders in S corporations, sole proprietors, and other independent contractors) are not employees for purposes of this fringe benefit.

When are qualified transportation fringe benefits excluded from income? If you provide a qualified transportation fringe benefit to an employee in place of compensation, you can't exclude the amount from the employee's income, except in the case of qualified parking. Amazingly, this is true even if your state or local laws require you to offer your employees a choice of receiving the benefit or higher compensation.

You should also note that you can't exclude a qualified transportation fringe benefit under the minimal or working condition fringe benefit rules — except, if you provide a local transportation benefit other than by transit pass or commuter highway vehicle, or to a person who is not considered an "employee" for purposes of the transportation benefit. In that case, you may be able to exclude all or part of the benefit under the other fringe benefit rules.

There are limitations on the amount you can exclude from your employee's wages for qualified transportation fringe benefits.

For 2014, you may exclude up to $130 a month (up to $245 per month for 2013) for combined commuter highway vehicle transportation (van pools) and transit passes. You may exclude $250 a month for qualified parking in 2014 ($245 per month for 2013). These amounts may be adjusted annually. If the fair market value of a benefit is more than its limit for any month, only the amount in excess of the limit, minus any amount paid for the benefit by or for the employee, is included in the employee's gross income.

In January of 2014, you paid $260 for each of your employees' parking spaces at Dentandbang Parking. Since this amount is greater than the $250 limit allowed by the IRS, you're going to have to increase your employees' reported wages by $10 ($260 - $250) every month.

On the other hand, let's say you paid $260 in both January and February for parking, but for the next ten months, Dentandbang reduces its rates to $245 per month. In this case, you'll still have to increase your employees' wages by $10 for January and February. The IRS does not allow you to "average" the annual expenses over 12 months. You are only allowed to consider those charges which are actually incurred for the month in making this determination.

Qualified bicycle commuting reimbursement. Employers may offer employees a qualified bicycle commuting reimbursement of up to $20 for every qualified bicycle commuting month in a calendar year. A qualified bicycle commuting reimbursement is an employer reimbursement during the 15-month period starting with the first day of the calendar year for reasonable expenses incurred by an employee during the calendar year for the purchase of a bicycle and accessories, and the repair and storage of a bicycle that is regularly used to ride to and from work.

A qualified bicycle commuting month is any month during which an employee regularly uses a bicycle for a substantial portion of travel between the employee's residence and the place of employment and the employee did not receive any other transportation fringe benefit. However, unlike other transportation fringe benefits, bicycle commuting benefits may not be provided pursuant to an elective salary reduction agreement.