Taxable & Non-Taxable Benefits: Definition & Examples

Lesson Transcript
Instructor: Natalie Boyd

Natalie is a teacher and holds an MA in English Education and is in progress on her PhD in psychology.

Explore how taxable and non-taxable benefits can be included in a worker's compensation package and understand their advantages and disadvantages. Review what compensation is before analyzing both taxable and non-taxable benefits. Updated: 01/13/2022

Compensation

Malik owns a company. He's made it his mission to hire and retain the best employees in the industry, and he's heard that a good way to do that is to offer benefits to his employees. However, he's also heard that there might be tax implications for offering certain benefits. What should he do?

Compensation is what a person is given in return for work. It includes both a worker's salary, or wages, as well as non-cash income, which are called fringe benefits. What Malik is thinking about is how fringe benefits might help his employees.

Fringe benefits can be taxable or non-taxable, depending on what the benefit is and how much it's worth. To help Malik sort through the tax implications of offering robust fringe benefits, let's take a look at taxable and non-taxable benefits.

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  • 0:04 Compensation
  • 0:53 Taxable Benefits
  • 2:23 Non-Taxable Benefits
  • 5:11 Lesson Summary
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Taxable Benefits

If Malik wants to pay for benefits like the use of a company car or a country club membership for his employees, he'll face some tax implications. That's because those are examples of taxable fringe benefits, which are included in a worker's income for purposes of taxes.

Taxable benefits include some meals, vacation trips, gift cards, tickets to events, and memberships to clubs. These types of benefits are generally taxed at fair market value, which is what the employee would pay for the benefit if they were to get it on their own. This may be different from what the company pays for it.

For example, maybe Malik's company is able to get tickets to a big concert at a steep discount. They buy a bunch of $300 tickets for the bargain price of only $100 each and then give the tickets to their employees. Each employee's pay stub would reflect an additional $300 of income, on which withholding will have to be done. Even though the company only paid $100, the fair market value of the tickets is $300.

This is the major disadvantage of taxable benefits: both the employee and the employer will have to pay various taxes on the fair market value of the benefit. However, because they are considered taxable income, taxable benefits also come with the advantage that they can boost the future Social Security benefits for many workers. That's because Social Security benefits are based on income, and their income is higher with taxable benefits included.

Non-Taxable Benefits

Malik is worried about providing his employees with benefits that increase their taxes. But he also doesn't want to completely do away with fringe benefits. What to do?

Malik can concentrate on non-taxable benefits, which are not taxed or only partially taxed. The IRS distinguishes between different types of non-taxable benefits: those that are completely tax free, those that are income tax free (but that require other taxes be paid), and those that are tax free up to a certain limit.

Benefits that are completely tax free include health insurance, retirement services (like a deferred compensation plan), and de minimis benefits, which are benefits that cost only minimal amounts. For example, let's say that Malik wants to provide snacks in the office for his workers. Snacks only cost a little money, so they are considered de minimis. Malik will not have to worry about income, Social Security, Medicare, or employment taxes on those.

Other benefits are income tax free because they aren't included in the employee's income but still require Social Security, Medicare, and/or employment taxes to be paid on them. A good example of this is adoption assistance programs. Let's say that Malik wants to pay for the cost of adoption for any of his employees who want to adopt a child. One of his employees adopts a baby, and Malik pays $15,000 toward the cost of the adoption. The employee does not have to pay income tax on that money, but the $15,000 will be subject to Social Security, Medicare, and employment taxes.

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