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 benefit programs are primarily designed for your employees, there are cases where business owners can participate. This depends 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.
What are fringe benefits?
Fringe benefits are offered on top of an employee's regular salary as part of a benefits package. While the term fringe benefits can apply to all employee benefits, we'll focus on the benefits listed in IRS Publication 15-B1.
Common fringe benefits include expense reimbursements, health benefits such as health reimbursement arrangements (HRAs), and employee stipends.
Other examples of fringe benefits include:
- Employee achievement awards
- Personal use of a company cell phone
- In-office perks like free meals, snacks, or coffee
- Flexible work hours and remote work
- Commuter benefits
- Paid time off (PTO) and sick leave
- Wellness programs
- Tuition assistance
- Retirement benefits
- Adoption assistance
- Dependent care services
Offering additional fringe benefits is an excellent way to increase employee satisfaction and reduce employee turnover. While some fringe benefits are voluntary, others are required by law. Federal benefit requirements include health insurance for organizations with 50 or more full-time equivalent employees (FTEs) and unemployment insurance. Some states may also require disability insurance, retirement plans, and workers' compensation insurance.
Fringe benefits are generally 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 popular fringe benefits, you can easily participate on a taxable basis. However, there are limitations on which types of business owners can use these additional 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. This also applies to limited liability companies that elect to be taxed as a corporation instead of a partnership.
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 S-corp and partnership business owners, there are a few exceptions. There are various tax-free 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 additional 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 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)
- Employer-provided cell phones
- If used for non-compensatory business reasons. It can't be for personal use outside of your organization
Partnerships and S-corps can pay for job-related education expenses and deduct the total cost tax-free. However, educational assistance programs limit how much 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.
Here's a list of fringe benefits that are taxable for employers:
- Accident and health benefits
- Don't treat it as a reduction in distributions for the owner
- 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 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 benefits, such as employee stipends, are taxable for both 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 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.
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 whatever type of fringe benefits you choose to offer.
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.
This article was originally published on June 27, 2022. It was last updated on May 25, 2023.