As an employer who is building or updating a benefits package to better recruit and retain employees, it’s important to understand how each benefit impacts your and your employees’ tax liability.
When you give employees fringe benefits like a gift card or access to a company car for personal use, your employees need to pay taxes on the value of these benefits. This is known as imputed income.
If you offer or plan to offer your employees various fringe benefits, you need to know which benefits are exempt and how to report imputed income on a W-2 form properly. In this article, we’ll go over everything you need to know about imputed income.
Learn more about the advantages of fringe benefits in our complete guide
What is imputed income?
Imputed income is the value of non-cash compensation given to employees—outside their salary or wages—in the form of fringe benefits. These benefits are separate from those paid for on a pre-tax basis and, therefore, not subject to income taxes, like health insurance and other health benefits, like health reimbursement arrangements (HRAs).
When you provide certain fringe benefits to your employees, imputed earnings must be treated as regular income and be reported and taxed as such unless they are exempt. For instance, a current employee who receives a $100 gift card for completing a project ahead of schedule must report that amount as imputed income.
Some fringe benefits are tax-free or tax-advantaged. You should consult with a tax professional to determine the tax status of your employee benefits.
Non-cash benefits are a great way to compensate your employees beyond their regular wages. In fact, voluntary benefits are becoming an increasingly essential part of employers’ overall benefits packages as the demand for flexible and personalized benefits grows.
In a survey1 conducted by McKinsey & Company, 78% percent of employers reported they offer at least one voluntary employee benefit. Even though fringe benefits can be taxable, offering them is an excellent way to support your employees’ well-being, enrich your compensation plan, and attract and retain talent.
How does imputed income affect your employees’ taxes?
Imputed income must be added to an employee’s gross income as taxable wages unless it’s considered exempt. You don’t include the amount in your employees’ net income because the employees received the benefit in another form.
However, you need to include it on your employees’ W-2 Forms for federal income taxes—but we’ll go into more detail on that later.
Generally, imputed income isn’t subject to federal income tax withholding, but it’s subject to Social Security taxes, federal unemployment taxes (FUTA), and Medicare taxes. Your employees can withhold a specific amount of tax to account for the imputed income throughout the year or pay the taxes due when filing their federal tax return.
In either case, you should inform your employees beforehand about the tax penalties that may apply if they don’t withhold enough federal taxes on their imputed income.
Examples of imputed income
Knowing what constitutes imputed income is important for reporting your organization’s taxes correctly. Many fringe benefits may be taxed depending on the value received by the employee, whereas other benefits are taxed regardless of the value or monetary amount received.
Some examples of items that are considered imputed taxable income include:
- Health insurance or other medical coverage for non-dependents, such as those in a domestic partnership
- Adoption assistance exceeding the annually adjusted amount
- Tuition reduction and educational assistance over the $5,250 tax-free limit
- Group term life insurance over $50,000
- Personal use of a company car
- Gym memberships and fitness incentives
- Company trips
- Dependent care assistance coverage over the $5,000 tax-free limit
- Moving expense reimbursements
- Employee discounts
- Occasional employee gifts, including cash and gift cards
The value of fringe benefits that your employees receive can also affect them outside of taxes. For example, imputed income can impact an employee’s child support payment amounts.
That is because, depending on the state, imputed income gives the judge a more accurate view of a non-custodial parent’s actual income, which helps to determine a more accurate child support amount they should pay.
Examples of exclusions to imputed income
Some benefits are excluded from being counted as imputed income. These are called “de minimis benefits,” and they are benefits that hold so little value and tax impact that the IRS finds it impractical or unnecessary to keep a record of them.
These exclusions include:
- Controlled, occasional employee personal use of photocopy machine
- Occasional office snacks
- Occasional tickets for entertainment events
- Holiday gifts (except gift cards, which are always taxable)
- Occasional meal allowance or transportation money for working overtime
- Group-term life insurance for employee spouse or dependent with a face value no more than $2,000
- Flowers, fruit, books, etc., provided under special circumstances
- Personal use of a cell phone provided by an employer primarily for business purposes
The IRS states2 that any fringe benefit valued less than $100 is considered a de minimis benefit. A vital aspect of a de minimis benefit is that it’s occasional or unusual in frequency, so considering frequency in addition to value is crucial to understanding if your benefit fits the de minimis criteria.
In most cases, excluded de minimis benefits aren't subject to federal income tax withholding, Social Security, Medicare, FUTA, or Railroad Retirement Tax Act (RRTA) taxes. They also don’t need to be reported on your employees’ W-2s.
How is imputed income reported for my employees?
Except for excluded benefits, like those listed above, fringe benefits are subject to employment taxes, so you must report them on each employee’s W-2 form at the end of the year. To do this, you must accurately track the value of each employee’s imputed income throughout the year, the same as regular wages.
To correctly report any taxable benefits, you need to determine the value of the benefits each employee has received.
While this may be simple for some benefits with assigned values, such as group-term life insurance and educational assistance, other fringe benefits, like personal use of a company car, may require you to determine the fair market value.
You can report imputed income on Form W-2 for each applicable employee in Box 12 using Code C. Also, you should include the amount for imputed income in Boxes 1, 3, and 5.
You can report your imputed income value at any frequency as long as it’s not less than annually.
Period reporting options include:
- Per pay period
- Quarterly
- Semi-annually
- Annually
You can change your reporting frequency as much as you like. However, you must report your benefits by December 31 of the year the benefits were received.
Looking to offer fringe benefits to your team?
If you’re looking to add fringe benefits to your benefits package you don’t have to go at it alone. PeopleKeep’s stipend administration software allows employers to reimburse their employees for lifestyle benefits that can be personalized to each employee. With WorkPerks, you can easily track your employees’ reimbursements, making it easier to see what you’ve paid out for tax reporting.
With PeopleKeep, you can control your costs by choosing allowance amounts that fit your budget. And best of all, most customers only need about five minutes per month of benefit administration, making our software completely hassle-free.
Conclusion
Imputed income is something all employers should understand. Whether you run your payroll manually or have a payroll service provider, you must track imputed income, report fringe benefits, and include the tax totals on your employees’ W-2s.
Because imputed income can be tricky initially, it’s also a good idea to inform your employees of any penalties that may apply if they don’t have sufficient tax withholdings. As with anything tax-related, it’s a good idea to contact your tax advisor or the IRS for official guidance and tax advice if you have questions.
This article was originally published on August 3, 2022. It was last updated on May 23, 2023.
1. https://www.mckinsey.com/industries/healthcare-systems-and-services/our-insights/employers-look-to-expand-health-benefits-while-managing-medical-costs
2. https://www.irs.gov/government-entities/federal-state-local-governments/de-minimis-fringe-benefits
