Guide to tax withholdings for stipends and fringe benefits

With a tight labor market caused by a record number of resignations and job openings over the last year, employers need to go above and beyond to attract and retain top talent. Additional benefits can do the trick.

Offering a competitive employee benefits package is a great way to hire and keep your workers, and many employers looking to enhance their benefits are turning to employee stipends and fringe benefits. But, as with any employee benefit, you need to know how to manage these perks, including understanding their taxability.

This article will explain tax withholdings for fringe benefits, whether employee stipends are taxable, and how to administer compliant employee perks.The content in this article is for educational purposes only. You should consult with your legal counsel and tax advisers to determine the proper steps for your organization.

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What is a fringe benefit?

Before we cover tax withholdings, let's explain what a fringe benefit is.

Fringe benefits are a form of indirect compensation provided to your employee in addition to their regular salary or wage. They can help offset the cost of work, travel, and living expenses. They can also be used to support professional development and recognition programs. While this term commonly refers to all employee benefits, the Internal Revenue Service (IRS) only categorizes certain perks as fringe benefits. The IRS lists these in IRS Publication 15-B¹.

Difference between pre-tax, taxable, and non-taxable benefits

It's essential that you understand the difference between pre-tax, taxable, and non-taxable benefits. For this section, we're referring to federal regulations only. Some states or local jurisdictions may have additional tax rules.

What are pre-tax benefits?

Pre-tax, or tax-advantaged benefits, are specific benefits that the IRS regulates and encourages organizations to offer. These benefits often provide an immediate tax break to employers and employees.

Tax-advantaged benefits are often deducted from an employee's paycheck before taxes and are not counted toward the employee’s total taxable income amount. It's important to note that not all pre-tax benefits work this way. Some benefits, such as adoption assistance, are exempt from federal income tax but not from Social Security, Medicare, or FUTA taxes.

Examples of pre-tax benefits include:

• Education assistance
• Flexible spending accounts (FSAs)
• Health savings accounts (HSAs)
• Health reimbursement arrangements (HRAs)

Pre-tax benefits also come with regulations, such as contribution limits. Because some of these benefits can be too complicated for many organizations to manage, some employers use a benefits administrator to help.

What are non-taxable benefits?

Non-taxable benefits are business expenses you can reimburse without paying federal or state taxes. This differs from pre-tax benefits because you generally don’t report them on your employees' W-2s. This is often the case with de minimis benefits ².

What are taxable benefits?

According to the IRS, any employee benefits not listed as pre-tax or that you can't designate as non-taxable are taxable. This means that you must report these benefits on your employees' Form W-2 as taxable income, and you'll also be required to withhold state and federal taxes.

Are stipends taxable?

Providing stipends to employees can be an excellent flexible benefit. Most employee stipends are considered taxable benefits. However, certain types of stipends, such as commuter or education benefits, may be tax-free up to the IRS-designated annual contribution limits. To do so, you must establish an accountable plan and follow IRS guidelines.

Some of the most popular taxable stipends are:

• Wellness stipends
• Health stipends
• Remote work stipends

Wellness stipends are taxable benefits given to employees to help cover their wellness expenses. They can be offered as a benefits card, such as a lifestyle spending account (LSA), or through an expense reimbursement. A wellness stipend can cover the cost of gym membership fees, home exercise equipment, wellness mobile apps, wearables and fitness trackers, and more.

You can also offer your employees a health stipend. Health insurance stipends are taxable alternatives to an HRA or a group health insurance plan. However, larger organizations with 50 or more full-time equivalent employees (FTEs) still need to provide a group health insurance policy or an HRA, as a health stipend doesn't meet the Affordable Care Act's employer mandate.

With a health stipend, you can reimburse your employees for their medical expenses, including mental health care. You can also offer them to your 1099 contractors and international employees.

Because a taxable stipend is a form of income, employers are responsible for payroll taxes, while employees could owe additional taxes on their tax returns. All fringe benefits, including stipends, are taxed at the employee's regular income tax rate, or employers can withhold 22% of the value. According to the IRS, the 22% flat rate can apply to all supplemental wages if your employee earns less than $1 million annually. Otherwise, employers must use a 37% flat rate¹.

Which benefits are taxable?

Use the chart below to quickly see which popular employee benefits are taxable or tax-free in regard to employment taxes. You should always consult with IRS Publication 15-B¹ and your tax professional to determine proper federal income tax withholding for your organization.

You should also note that giving employees a cash payment or gift card is always considered a taxable benefit, even if the amount is small.

How to administer a compliant taxable employee stipend

If you've elected to offer your employees taxable benefits, you need to be sure you're correctly administering your benefits.

The IRS requires employers to determine the value of fringe benefits by January 31 of the following year. You'll have to estimate the amount before then. For employee stipends, this should be the total amount of the stipends paid out.

There are two standard options for remaining compliant with taxable benefits:

1. Provide employees with a 100% reimbursement. Then you can withhold taxes later on their W-2 using imputed pay. For this value, use your employees' regular income tax withholding rate³ or the standard federal income tax rate of 22%. You'll also need to withhold Medicare, Social Security, and FUTA taxes
2. Treat the fringe benefit’s value as a bonus for the payroll cycle and withhold all applicable taxes

How to administer a compliant tax-free employee benefit

While pre-tax benefits are exempt from federal taxes as long as they remain compliant, they require additional work to ensure that you comply with the additional IRS and federal regulations.

For example, you'll need to ensure that employees submit substantiation for their medical reimbursements with an HRA. This includes receipts, bills, or doctor's notes, depending on the qualified expense. Additionally, health benefits will subject your organization to HIPAA and other privacy regulations.

Using a benefits administration software like PeopleKeep can help your HRA remain compliant.

You should consult with a tax professional to determine how to offer tax-free employee stipends to your employees.

Conclusion

Knowing the difference between pre- and post-tax fringe benefits will help you offer the right benefits for your organization. Pre-tax benefits can reduce the overall taxable income for your employees while saving you money, but taxable benefits are often easier to administer.

No matter which benefits you choose to offer, remaining compliant allows you to avoid costly penalties from the IRS.

Hopefully, this article helped you understand how to withhold taxes for fringe benefits. If you need tax advice, you should contact a tax professional to ensure your organization stays compliant.

If you're interested in offering tax-free or taxable benefits, PeopleKeep can help! Our HRA and employee stipend benefits administration software makes it easy to manage your benefits in minutes every month.

Offset employee expenses with customized perks. Schedule a call with a personalized benefits advisor today!

1. https://www.irs.gov/publications/p15b
2. https://www.irs.gov/government-entities/federal-state-local-governments/de-minimis-fringe-benefits
3. https://www.irs.gov/publications/p15b#en_US_2022_publink1000193805