With a tight labor market caused by a record number of resignations and job openings, employers need to go above and beyond to attract and retain top talent.
Offering competitive employee benefits packages is a great way to attract and retain your employees, with many employers looking 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 intended for educational purposes only. You should consult with your legal counsel and tax advisers to determine the proper steps for your organization.
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. While this term commonly refers to all employee benefits, the Internal Revenue Service (IRS) only categorizes certain perks as fringe benefits listed 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 deducted from an employee’s paycheck before taxes, lowering the 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 that can be complicated for many organizations to manage. That’s where a benefits administrator can help.
What are non-taxable benefits?
Non-taxable benefits are business expenses that you can reimburse without paying federal or state taxes. This differs from pre-tax benefits because they aren’t generally reported on your employees' W-2s. This commonly seen with de minimis benefits 2.
What are taxable benefits?
According to the IRS, any employee benefits that aren’t explicitly listed as pre-tax or that can’t be designated as non-taxable are taxable. This means that the taxable fringe benefits must be reported 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 stipends, such as commuter or education benefits, may be considered tax-free up to the IRS-designated annual contribution limits.
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. This can be in a benefits card, such as a lifestyle spending account (LSA), or through an expense reimbursement. Wellness expenses that employees could get reimbursed with a wellness stipend include 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 a 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.
Health stipends allow employees to be reimbursed 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 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.
Which benefits are taxable?
Use the chart below to quickly see which popular employee benefits are taxable or tax-free in regards to employment taxes. You should always consult with IRS Publication 15-B1 and your tax professional to determine proper federal income tax withholding.
|
Fringe benefit |
Federal income taxability |
Social Security & Medicare taxability |
|
Accident and health benefits |
Tax-Free |
Tax-Free |
|
Achievement awards |
Tax-free up to $1,600 for qualified plan awards, $400 for nonqualified awards |
Tax-free up to $1,600 for qualified plan awards, $400 for nonqualified awards |
|
Adoption assistance |
Tax-Free |
Taxable |
|
Archer medical savings accounts (MSAs) |
Tax-free for qualified medical expenses |
Tax-free for qualified medical expenses |
|
Athletic facilities |
Tax-free if it is only used by employees and their families and is operated by the employer. |
Tax-free if it is only used by employees and their families and is operated by the employer. |
|
Bicycle commuter reimbursement |
Taxable |
Taxable |
|
Commuter benefits |
Tax-free up to $280/month for transit passes or commuter highway vehicles. Up to $280/month for parking. |
Tax-free up to $280/month for transit passes or commuter highway vehicles. Up to $280/month for parking. |
|
De minimis benefits |
Tax-Free |
Tax-Free |
|
Dental insurance |
Tax-Free |
Tax-Free |
|
Dependent care assistance |
Tax-free up to $5,000 |
Tax-free up to $5,000 |
|
Disability insurance |
Tax-free if for loss of bodily function or limb. Otherwise, employees pay income taxes. |
Tax-free if for loss of bodily function or limb. Otherwise, employees pay income taxes. |
|
Educational assistance |
Tax-free up to $5,250/year per employee |
Tax-free up to $5,250/year per employee |
|
Employee discounts |
Tax-free up to 20% of the normal price |
Tax-free up to 20% of the normal price |
|
Employee stock options |
The stock option price discount is taxable upon qualifying disposition of stock |
|
|
Employer-provided cell phones |
Tax-free if provided for business reasons |
Tax-free if provided for business reasons |
|
Flexible spending account (FSA) |
Tax-Free |
Tax-Free |
|
Group-term life insurance coverage |
Tax-free |
Tax-free up to $50,000 of coverage |
|
Health insurance |
Tax-Free |
Tax-Free |
|
Health savings account (HSA) |
Tax-free up to contribution limit, including employer contributions |
Tax-free up to contribution limit |
|
Health stipend |
Taxable |
Taxable |
|
Health reimbursement arrangement (HRA) |
Tax-free for qualifying medical expenses |
Tax-free for qualifying medical expenses |
|
Lodging on-premises |
Tax-free if lodging on the business premises is a condition of employment |
Tax-free if lodging on the business premises is a condition of employment |
|
Retirement planning services |
Tax-Free |
Tax-Free |
|
Vision Insurance |
Tax-Free |
Tax-Free |
|
Wellness stipends |
Taxable |
Taxable |
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 that you’re correctly administering your benefits.
The IRS requires employers to determine the value of fringe benefits no later than January 31 of the following year. You’ll have to estimate the amount before then.
There are two standard options for remaining compliant with taxable benefits:
- 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
- Treat the fringe benefits value as a bonus for the payroll cycle and withhold all applicable taxes
Using a benefits administrator can help ensure that you remain compliant with your taxable benefits.
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 remain compliant 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 expenses being reimbursed. Additionally, health benefits will subject your organization to HIPAA and other privacy regulations.
Using a benefits administration software like PeopleKeep can help you remain compliant.
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 have a tax question, 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 while keeping you compliant.
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
