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.
Finally, some benefits are tax free up to certain dollar limits. Examples of this include educational assistance programs, which are tax free up to $5,250 in the 2019 tax year, and transportation benefits, which are tax free up to $265 in the 2019 tax year. So if Malik wants to pay $5,000 per year for any employee to take a class at a local college, or if he wants to provide $250 per year of vouchers for public transit, they will be tax free. If Malik pays $6,000 toward education or $600 toward transportation, only part of that will be non-taxable. The rest would be taxable.
An advantage of non-taxable benefits is that there are few, if any, taxes to pay on them. In addition, there is less paperwork to keep track of and companies don't have to calculate the fair market value of benefits. But there are some disadvantages, too. The main one is that non-taxable benefits are limited in the scope and amount of the benefit. In addition, non-taxable benefits often do not boost workers' future Social Security benefits.
Lesson Summary
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. Fringe benefits can be taxable or non-taxable, depending on what the benefit is and how much it's worth.
Taxable fringe benefits are included in a worker's income for purposes of taxes. They include use of a company car, 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.
Both the employee and 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 can boost the future Social Security benefits for many workers.
Non-taxable benefits are not taxed or only partially taxed. Benefits that are completely tax free include health insurance, retirement services (like a deferred compensation plan), and de minimis benefits, which are those that cost only minimal amounts. Other benefits, such as adoption assistance programs, 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. Finally, some benefits are tax free up to certain dollar limits. Examples include educational assistance programs and transportation benefits.
Advantages of non-taxable benefits include that there are few, if any, taxes to pay on them, there is less paperwork to keep track of, and companies don't have to calculate the fair market value of benefits. Disadvantages include that non-taxable benefits are limited in the scope and amount of the benefit and often do not boost workers' future Social Security benefits.
