In addition to your salary, wages, or other compensation for your work, you may be receiving fringe benefits. Some of these benefits are included in your taxable income, others may be excluded from tax, and others may qualify for exclusion subject to certain conditions or limits. In some cases you may need to file a certain tax form in order to exclude benefits from your taxable income.
What Are Fringe
Benefits for Tax Purposes?
federal income tax purposes, a fringe benefit is considered a form of pay for
the performance of services, and is taxable unless the tax law specifically
excludes it from taxation. Persons who perform services include employees,
independent contractors, partners, and directors. Fringe benefits could also
include payments or other benefits for not performing services, such as under a
covenant not to compete, for example.
Provider of Fringe Benefits
The company or person for whom you perform services (your employer or the
company that contracts you) is considered the provider of the fringe benefits
and is responsible for including the fringe benefits in your compensation and
withholding income tax. This is the case even though the benefits themselves
may be furnished by a third party, such as an insurance company or health care
provider, or one of your employer’s customers or clients, for instance. And, as
the person who is performing the services, fringe benefits provided to a member
of your family, or other dependent or beneficiary, are taxable to you.
General Rule on Taxability
Fringe benefits are taxable to the extent they are not specifically excluded
under the income tax law, and to the extent you do not pay for them. In
addition to income tax, fringe benefits are subject to employment, or payroll
taxes (social security and Medicare) if you are an employee, unless they are
Where Fringe Benefits Are Reported
The value of fringe benefits that you receive as an employee are included in
box 1 of your Form W-2, Wage and Tax Statement, and may also be reported
separately in box 12 with the appropriate code. If you are an independent
contractor, the value of the fringe benefits would be included in your Form
1099-MISC, and if you are a partner, in Schedule K-1 (Form 1065).
A cafeteria plan allows employees to choose between receiving cash or
taxable benefits instead of certain qualified benefits that could be excluded from
Taxability of Qualified Benefits
If an employee chooses a qualified benefit, the fact that cash or a taxable
benefit could have been chosen does not make the qualified benefit taxable.
Therefore, qualified benefits provided under a cafeteria plan can be tax-free.
Cash payments or unqualified benefits would be taxable.
What Can Be Included
Cafeteria plans do not normally include any deferred payment benefit plans,
although they can include a qualified 401(k) plan. Other qualified benefits
that could be included in cafeteria plans are accident and health benefits (but
not medical savings accounts or long-term care assistance), adoption
assistance, dependent care assistance, and group-term life insurance coverage.
What Cannot Be Included
A cafeteria plan cannot include Archer medical savings accounts, athletic
facilities, de minimus benefits, educational assistance, employee
discounts, lodging on business premises, meals, moving expense reimbursements,
no-additional-cost services, transportation (commuting) benefits, tuition
reduction, working condition benefits, or scholarships or fellowships. These
benefits are treated separately.
Plans that Favor Highly Compensated Employees
If a cafeteria plan favors highly-compensated employees, in terms of
eligibility to participate, and the contributions and benefits provided, the
beneficiaries’ compensation will include the value of the taxable benefits they
could have selected. Highly compensated employees, for this purpose, include
officers and shareholders who own more than 5% of the employer’s stock,
employees who are highly compensated based on the facts and circumstances, and
the spouses and dependents of any of these employees.
Plans that Favor Key Employees
As in the case of highly-compensated employees, if a plan favors key
employees, they are taxed on the value of taxable benefits they could have
selected. A plan is considered to favor key employees if more than 25% of the
total nontaxable benefits go to key employees. Key employees include officers
who receive annual pay over a certain amount, employees who own at least 5% of
the business, and employees who own at least 1% of the business and receive
annual pay over a certain amount. The amounts may change year by year, and are
published by the Internal Revenue Service.
Fringe benefit exclusion rules exclude part or all of certain benefits from
federal income tax. In some cases, they also exclude benefits from social
security and Medicare taxes.
Accident or Health Plan
Accident or health plans are arrangements that provide benefits for
employees, their spouses, and dependents in the event of personal injury or
sickness. Employer contributions may be made toward the cost of accident or
health insurance, or to a separate trust or fund that provides accident and
health insurance benefits either directly or through an insurance carrier.
Generally the value of coverage provided by your employer is not included in
your taxable income for federal income tax purposes or social security and Medicare
purposes. This exclusion applies to payments made directly to employees or
beneficiaries, and payments made indirectly, on their behalf, and includes
reimbursements of medical expenses, and payments for specific injuries or
Whose Benefits Are Excluded
The exclusion of these benefits from taxable income applies to current
employees, full-time insurance agents (statutory employees), retired employees,
former employees for whom coverage is maintained based on the employment
relationship, widows and widowers of former employees, and contracted persons
(“leased” employees) who have provided services on a substantially full-time
basis for at least one year.
Contributions made through a cafeteria plan must be included in income. These
would be reported on your W-2.
Exception for Long-term Care Benefits
The cost of long-term care insurance is not exempt from federal income tax
if coverage is provided through a flexible spending or similar type of
arrangement that reimburses specified expenses up to a certain maximum amount.
But these benefits are excluded from social security and Medicare taxes.
Exception for Highly Compensated Employees
A self-insured medical reimbursement plan that favors highly compensated
employees is subject to income tax, but is exempt from social security and
Medicare taxes. For this purpose, a highly compensated employee is:
One of the five highest paid
An employee who directly or
indirectly owns more than 10% of the employer’s stock, or
An employee who is among the
25% highest paid of all employees.
Archer MSA Contributions
Contributions your employer makes to your Archer MSA (Medical Savings
Account) are not included in your taxable income. They are reported in box
12, code R on your W-2, and you should report them on Form 8853,
Archer MSAs and Long-Term Care Insurance Contracts.
Health Flexible Spending Arrangements (Health FSA’s)
If your employer’s plan qualifies as an accident and health plan, the
amounts deducted from your salary or wages and the benefits paid for you and
your dependents are generally not taxable. This same exclusion applies for
Health Reimbursement Arrangements (HRAs).
Tangible personal property received as an award for length of service or
other type of achievement is not subject to tax. This exclusion does not apply
to cash, stocks, bonds, securities, gift certificates, or intangible awards
such as vacations, meals, lodging, or tickets to sporting or other events.
The amounts your employer pays or the expenses it incurs in connection with
the adoption of your child are exempt from federal income tax, but are subject
to social security and Medicare taxes. These amounts are reported on your W-2,
in box 12, code T. You will need tocomplete Form 8839, Qualified
Adoption Expenses, to see if you can exclude all or part of these benefits from
your taxable income.
If your employer allows you and your dependents to use a gym or other
athletic facility on the employer’s premises, the value is not included in your
compensation and is not taxable. The athletic facilities must be on property
owned or leased by your employer, but do not necessarily have to be on its
business premises. The athletic facility must be principally for use by
employees, their spouses, and dependent children during the entire year.
However, if your employer pays for an athletic program at an off-site facility,
the value of the program is taxable income to you.
De Minimus (Minimal) Benefits
The value of products and services that your employer provides you, that
have a low cost, such as a company cafeteria, cab fares home when working
overtime, and company picnics, are not included in your income. If your
employer gives you a holiday gift, such as a ham or turkey, this is not
included in your income either. But if your employer gives you cash, a gift
certificate, or a similar item that can be readily converted to cash, that
amount is included in your taxable income.
Dependent Care Benefits
These are benefits that your employer pays directly to you or to a care
provider to care for your qualifying person while you work, or the fair market
value of care in a daycare facility provided or sponsored by your employer.
These benefits are reported in box 10
of your W-2. You can exclude these benefits from your income, up to a maximum
of $5,000 ($2,500 if married filing separately). Any benefits over $5,000 will
be included in box 1 of
your W-2 as taxable compensation.
To exclude dependent care benefits paid or provided by your employer, you
will need to file Form 2441, Child and Dependent Care Expenses, if you file
Form 1040, or Schedule 2 if you file Form 1040A.
Dependent care benefits that favor highly compensated employees are not
excludible. For these purposes, a highly compensated employee is one who owned
5% or more of the employer’s stock at any time during the current or preceding
year, or who earned over a certain amount (published by the IRS) and was in the
top 20% of employees in terms of pay ranking during the preceding year.
You can exclude up to $5,250 of qualified educational assistance payments
provided by your employer, for undergraduate or graduate level studies. In
order to qualify, the program must meet the following tests:
Rules for qualifying for
educational assistance do not favor highly compensated employees.
Not more than 5% of the
program’s benefits during the year are for shareholders or owners.
The program does not allow
employees to choose cash or other taxable benefits instead of educational
The employer gives notice of
the program to all eligible employees.
The program can cover current employees, former employees if the benefit is
based on their employment, leased employees who have performed substantially
full-time services for at least one year, yourself (if you are a sole
proprietor), and partners, in the case of a partnership.
Highly compensated employees, for purposes of the educational assistance
program tests, are defined the same as for dependent care benefits programs.
If your employer sells you property or services at a discount, you may be
able to exclude the discount from your income. The discounts must be on
property or services your employer sells to customers in the ordinary course of
the line of business.
Excludible discounts apply to current employees, former employees, widows
and widowers of former employees, leased employees, and partners who perform
services for a partnership.
There are limits on the amount of discounts that can be excluded from
Discounts on services cannot
be more than 20% of the amount charged to regular customers.
Discounts on merchandise or
property cannot be more than the business’s gross profit percentage on the
price normally charged to regular customers.
Discounts are not excludible if they are granted only to highly compensated
employees, and not to all employees or to a group of employees defined
according to a reasonable classification that does not favor highly compensated
employees. Highly compensated employees, for purposes of the employee discount,
are defined the same as for the educational assistance program tests, and the
dependent care benefits programs.
Financial Counseling Fees
Financial counseling fees paid for you by your employer are included in your
taxable income. But you may be able to deduct these expenses on Schedule A as a
miscellaneous itemized deduction.
Personal use of an employer-provided vehicle is a taxable non-cash fringe
benefit. Your employer must determine the amount to be included in your income
as reported on your W-2. This would generally be the fair market value, which
would be the amount you would have to pay a third party to lease the same or a
similar vehicle on the same or comparable terms in the geographic area where
you use the vehicle.
If you use the vehicle for both personal and business use, you may be able
to take an itemized deduction for the business use of the vehicle.
Meals and Lodging
The value of meals and lodging provided to you and your family by your
employer are not included in your taxable income if:
The meals and lodging are
furnished on your employer’s business premises,
The meals and lodging are
furnished for the convenience of your employer, and
The lodging is a condition of
This exclusion also applies to de minimis meals, or meal money that
has so little value that accounting for them would be unreasonable or impracticable.
This includes items such as coffee, doughnuts, soft drinks, occasional meals or
meal money for working overtime, and occasional company parties or picnics for
employees and their guests.
Company-provided eating facilities are also excluded from income if the
annual revenue of the facility equals or exceeds the direct cost of operating
the facility. Meals provided at a company facility for highly compensated
employees, that are not available to all employees or to a group of employees
that does not favor highly compensated employees, are not excludible.
Whether meals are provided for the convenience of the employer depends on
the circumstances. There must be a substantial business reason for providing
the meals. For this purpose, if more than half of the employees are provided
with meals for the convenience of the employer, it is considered that all
employees are provided meals for the employer’s convenience, and they are
excludible from the employees’ taxable income.
Moving Expense Reimbursements
If your employer directly or indirectly pays for moving expenses that would
have been deductible if you had paid them, the payments are not included in
your income. If your employer pays you a moving expense allowance, you should
include it in your taxable income and report your actual moving expenses on
These are excess capacity services such as airline, bus, or train tickets,
hotel rooms, or telephone service provided to you as an employee for free, at
cost, or at a reduced price. These are not included in your income if your
employer provides the same services to customers in the ordinary course of the
line of business, and it does not have a substantial additional cost to provide
you with the services.
Reciprocal agreements for an unrelated employer to provide
no-additional-cost services may qualify for exclusion if the following tests
The service is the same type
of service provided by your employer in the line of business in which you
Your employer and the
unrelated employer have a written reciprocal agreement under which a group
of employers from both employers may receive no-additional-cost services
from the other employer.
Neither employer incurs any
substantial additional cost in providing the service.
Group-Term Life Insurance
The cost of group-term life insurance coverage provided by your employer is
exempt from federal income tax, and up to $50,000 of group-term life insurance
coverage is also excluded from wages subject to social security and Medicare
taxes. The cost of coverage over that amount is subject to social security and
Medicare tax, and will be reported in box 12, code C on your W-2.
In order to qualify as excludible, the group-term life insurance must
provide a general death benefit that is not included in employees’ income, the
policy must cover at least 10 full-time employees, and the insurance must be
based on a formula that prevents individual selection.
There are certain exceptions to the 10 full-time employee requirement:
Evidence of an employee’s
insurability must be limited to a medical questionnaire and not a
Insurance is provided to all
Coverage must be based on a
uniform percentage of pay, or the insurer’s coverage brackets.
Employees for this purpose include current employees, full-time insurance
agents (statutory employees), former employees, and leased employees who have
provided substantially full-time services for at least one year.
The cost of coverage in excess of $50,000 must be included in employees’
compensation subject to social security and Medicare taxes, reduced by the
amounts employees pay for this coverage.
If group-term life insurance favors key employees, the entire cost of the
coverage is included in those key employees’ wages subject to social security
and Medicare taxes.
Retirement Planning Services
Retirement planning services provided by your employer are not included in
your income. This does not apply to services for tax preparation, accounting,
legal, or brokerage services.
Qualified transportation fringe benefits provided by your employer can be
excluded from your income up to certain limits. Qualified benefits include the
following, up to a certain amount per month, which may change year by year.
These amounts can be found in IRS instructions and publications:
Transportation in a commuter
highway vehicle (such as a van) between your home and work place,
A transit pass (for mass
transportation fares), or
If the transportation benefit exceeds the exclusion amounts, the excess is
taxable income to you.
Retirement Plan Contributions
The contributions your employer makes to a qualified retirement plan for you
are not included in your taxable income at the time the contributions are made.
But if your employer makes payments into a plan that is not qualified according
to the IRS, these contributions would be taxable to you. However, if your
interest in the plan is not transferable to you, or is subject to a substantial
risk of losing it at the time of the contribution, you do not have to include
the value of that contribution in your income until it is transferable or is no
longer subject to a substantial risk of forfeiture.
Outplacement services qualify for exclusion from income as a
working condition benefit; to the extent you could deduct the expense if you
had paid for it yourself (as a job hunting expense under miscellaneous itemized
deductions). The outplacement services would not be excludible if you could
choose to receive cash instead. For example, if you agree to accept
outplacement services in exchange for a reduction in your severance pay, the
amount of the reduction would be included in your taxable income.