When choosing which benefits to offer to their employees, many organizations choose flexible fringe benefits instead of, or in addition to, traditional employee benefits.
Many business owners whose companies offer fringe benefits ask, “Can I participate in my organization’s fringe benefits programs?”
Understanding how fringe benefits work for business owners can be challenging. While fringe benefits are primarily designed for your employees, there are cases where business owners can participate. This is dependent on your tax filing status, the type of organization you own, and the individual fringe benefits you offer.
This article explains how owners and their family members can determine if they can use fringe benefits such as employee stipends.
Read our guide on fringe benefits for an expert walkthrough on how they work
What are fringe benefits?
Fringe benefits are indirect compensation offered to employees as part of an employee benefits package. While the term fringe benefits can apply to all employee benefits, for this article, we’ll focus on the benefits listed in IRS Publication 15-B1.
Common fringe benefits include employee achievement awards, adoption assistance, athletic facilities, commuter benefits, expense reimbursements, health benefits such as health reimbursement arrangements (HRAs), employee stipends, and more.
All fringe benefits are considered taxable unless the IRS or federal law specifically excludes a particular benefit from taxes.
How do fringe benefits work for owners?
Sometimes, employers want to participate in the same benefits programs as their employees. With many types of fringe benefits, you can easily participate on a taxable basis. However, there are limitations on which types of business owners can use these benefits on a tax-free basis.
How do fringe benefits work for C-corporation owners?
A C-corporation is a legal entity separate from the owners. Therefore, owners of a C-corp are considered employees. A corporation owner, their spouse, and their dependents are eligible for fringe benefits.
Taxable fringe benefits and stipends must be reported on an owner’s Form W-2 as income, while tax-advantaged benefits are excluded from income.
C-corp owners are eligible to participate in almost all types of fringe benefits, including HRAs.
How do fringe benefits work for S-corporation owners?
An S-corporation, or S-corp, is a business that isn’t subject to corporate income tax. Instead, every shareholder who owns 2% or more of the organization is taxed.
An owner with 2% or more of the company’s shares, their spouse, and dependents can use taxable fringe benefits with some special rules. Since S-corp shareholders aren’t employees and are instead considered self-employed, the value of the fringe benefits must be reported as additional taxable income on IRS Schedule K-1 (Form 1065) in the Partner’s Share of Income, Deductions, Credits, etc. section.
How do fringe benefits work for a sole proprietorship or partnership?
Partners (and owners of a limited liability company who are taxed as a partnership), sole proprietors, and S-corp shareholders who own at least 2% of shares all have the same rules regarding IRS Publication 15-B benefits.
Partners’ taxable income from the fringe benefits is reported on Schedule K-1. Partners aren’t eligible for many tax-advantaged benefits, but there are exceptions.
Which tax-advantaged benefits are available to S-corp and partnership owners?
While most fringe benefits are taxable for business owners, there are a few exceptions. There are various nontaxable fringe benefits available to employers and employees.
Tax-free benefit options for partners and S-corp shareholders include:
- Qualified retirement plan contributions
- Education assistance up to $5,250
- You can’t offer more than 5% of the total benefits offered to 2% S-corp shareholders, partners, or their families, or the entire benefit loses its tax-free status
- Dependent care assistance programs up to $5,000
- No more than 25% of the benefits paid can be to 5% or more owners of the company
- Qualified retirement planning services
- No-additional-cost services
- It must be the exact benefit available to all of your employees, or it is taxable
- Qualified employee discounts
- Must be the same discount amount available to all employees, or it is taxable
- Working condition fringe benefits
- De minimis benefits
- Cash and gift card payments are always taxable
- Use of on-premises, employer-run athletic facilities
- Tuition reduction if used for undergraduate education (or graduate education if you teach or perform research)
- Work cell phones
- If used for noncompensatory business reasons. It can’t be for personal use outside of your organization
It’s worth noting partnerships and S-corps can pay for job-related education expenses and deduct the total cost tax-free. However, educational assistance programs limit the amount that you can contribute to owners and their dependents.
Which taxable fringe benefits are available to S-corp shareholders, partnerships, and sole proprietors?
Some fringe benefits are taxable to all employees, while others are taxable to business owners. You must report the total amount of any taxable fringe benefits and withhold federal income tax, Social Security, and Medicare.
Taxable fringe benefits for employers include:
- Accident and health benefits
- Don’t treat it as a reduction in distributions for the owner
- Paid time office (PTO)
- Personal use of company vehicles
- Disability insurance
- Group-term life insurance coverage
- The full amount is taxable to partners and S-corp shareholders, not just for coverage of more than $50,000. However, you are only taxed on Social Security and Medicare, not federal income taxes
- Employee achievement awards
- Don’t treat it as a reduction in distributions for the owner
- Qualified transportation fringe benefits
- Adoption assistance programs
- Can’t pay 5% or more of the total yearly payments to shareholders or owners (anyone with more than 5% of the stock, capital, or profits)
- Meals and lodging for convenience
Other taxable benefits such as employee stipends are available for employers and employees.
A health stipend allows you to provide a payment card or reimburse your employees (and yourself) for medical expenses such as health insurance premiums and out-of-pocket healthcare expenses. This is an excellent option for organizations with independent contractors and international workers as well, as those employees are eligible for the benefit.
A wellness stipend is another popular taxable employee stipend. This allows you to reimburse your employees for their wellness expenses such as gym memberships, fitness classes, wearables and devices, home exercise equipment, and more wellness-related expenses.
If you or your employees work from home, you can offer a remote work stipend to help employees cover their home internet access costs, cell phone bills, and home office setup costs.
Which fringe benefits aren't available to business owners?
There are some fringe benefits that S-corp shareholders, partners, and sole proprietors are ineligible for.
Partners and 2% shareholders aren’t eligible to participate in a tax-advantaged Section 125 cafeteria plan, such as a health savings account (HSA) or flexible spending account (FSA). However, you can still participate in these plans on a taxable basis. Owners can’t treat cafeteria plans as a reduction in distributions.
For HSAs in particular, partners and S-corp shareholders aren’t eligible for pre-tax contributions. Instead, treat contributions as distributions or guaranteed payments.
S-corp owners and partners are ineligible to receive tax-free reimbursements through an HRA. However, a partner can receive tax-free reimbursements if their spouse is a W-2 employee of the organization.
How to determine the value of fringe benefits for taxes
According to the IRS, most organizations use the general valuation rule to determine the value of fringe benefits for federal income tax purposes. This is based on the fair market value (FMV), which is how much an employee would have to pay a third party to buy or lease the benefit.
It’s important to remember that neither the value an employee or employer perceives in the benefit nor the amount you paid for the benefit is considered FMV.
You must report this amount on W-2s and to the IRS by January 31 of the following year.
For federal income tax withholding, the IRS allows you to use a flat 22% rate on the FMV of fringe benefits. You must also withhold a 1.45% rate for Medicare and an additional 0.9% on any amounts above $200,000 in total wages to an employee or employer.
Many fringe benefits enable business owners to take advantage of their benefits packages. While most benefits are taxable to S-corp shareholders, partners, and sole proprietors, a few exceptions allow you to make the most of your benefits.
If you’re looking to offer taxable employee stipend benefits that you and your employees can use, PeopleKeep can help! Our benefits administration software allows organizations to set up and manage their benefits in minutes.
Schedule a call with a personalized benefits advisor today to see how taxable employee stipends can work with your organization