A fringe benefit is anything (cash, property, or services) that an employee receives from an employer in addition to regular earnings. The two main types of fringe benefits are perks and retirement or deferred compensation plans.
Perks provide an immediate economic and financial advantage to recipients (for example, moving expenses reimbursement, employee stock options, and personal use of a company car). The Internal Revenue Code (IRC) stipulates all fringe benefits are taxable compensation unless specifically excluded under the law.
Retirement or deferred compensation plans are employer-sponsored programs that accumulate funds to pay employees at a future date, normally at retirement (as with pension plans, profit-sharing plans, and simplified employee pension plans). Retirement plans are either qualified or non-qualified.
Qualified plans satisfy the requirements of the IRC. A qualified plan (such as a profit sharing plan, defined contribution plan, defined benefit plan, or 401(k) plan) provides advantageous tax treatment. The employer receives an immediate business deduction, and the employee's tax liability is postponed until he constructively receives the wages.
Non-qualified plans do not comply with the IRC and IRS requirements for favorable tax treatment. Some employers intentionally design plans that will never qualify because it allows them to discriminate in favor of one employee or a small group of employees.
An employer can treat a taxable non-cash fringe benefit as paid each pay period, quarterly, or at any time, as long as it is paid at least annually. An employer:
does not have to use the same time period for each employee
does not have to select formal payment dates or notify the IRS of the dates selected
may change reporting periods
may treat a benefit as paid on more than one date even if the employee received the entire benefit at one time, and
must treat all benefits provided in a calendar year as paid by December 31 of the calendar year unless the benefit qualifies under the Special Accounting Rule. Under the Special Accounting Rule, an employer may treat the value of non-cash fringe benefits actually provided during November or December as paid in the next calendar year.
Generally, any cash or non-cash fringe benefit that does not qualify for exclusion under a specific Internal Revenue Code provision is taxable and must be included in the recipient’s pay. The amount included is the amount by which the value of the benefit exceeds the sum of:
any amount the law excludes from pay and
any amount the recipient paid for the benefit.
All employee taxable fringe benefits are subject to employment taxes and are reported on Form W-2. If a taxable fringe benefit is for an independent contractor, the benefit is not subject to employment taxes and is reported on Form 1099-MISC. State and SUI taxability usually, but not universally, follow federal and FUTA.
An employer can handle withholding in one of two ways:
The value of the fringe benefit can be added to total compensation as other compensation for a payroll period. When withholding taxes are calculated, the value is included in taxable compensation.
or
Federal income tax can be withheld on the value of the fringe benefit at the flat supplemental wage rate (25%, or 35% if supplemental wages paid to an employee exceed one million dollars year-to-date for 2006).
If an employer pays an employee’s social security, Medicare, or federal income tax on fringe benefits, the amount paid by the employer must be reported in the employee’s income (referred to as “grossing up” – IRS Publication 15-A, Employee’s Portion of Taxes Paid by Employer).
For specific fringe benefits, calculations, and taxability, refer to: