Taxable vs Non-Taxable Benefits

As it becomes harder to attract and retain talent and also to help deal with soaring inflation, many employers are looking for ways to provide employees with tax-free benefits in order to entice employees to join or stay and help mitigate the impact of the rising costs. However, both employers and employees need to be aware that even despite their best intentions, many benefits or incentives can be considered taxable income – which from the employer side would require both withholding and reporting and would be includable in income for employees.

Generally speaking there is a presumption that anything of value conferred to an employee by an employer is considered compensation. A famous tax court case in this matter is Commissioner vs Duberstein where the president of one corporation “gifted” another a Cadillac in exchange for sales leads; the company that gave the car took a deduction however the person who received it did not pick it up as income and went to tax court to try and argue its status as a gift (which is non-taxable to a recipient) – and lost. The famous axiom many tax advisors use as a result of this case was that if the recipient was correct “we would all be paid in Cadillacs.” Ergo, it is important to consider (even if the intention may not be compensatory) all transactions between employees and employers.
Beyond compensation, most employers will offer an employee a “standard” benefits package. These would typically include:

• Company paid Health, Dental and Vision Insurance
• Life Insurance
• Disability Insurance
• 401(k) Plan and Match

Amounts paid for Health, Dental and Vision insurance – often a given now – are one of the areas where an employee can receive something of value (the coverage) and not have taxable income under current IRS law – as such, these would be considered “non-taxable benefits.” Similarly, amounts paid for disability insurance fall under the same umbrella as non-taxable. A 401(k) plan which has an employer match (either in the form of a periodic match or employer contribution) is not currently taxable compensation to the employee but will be in the future when drawn from the plan in retirement. Life insurance, however, falls into a unique situation – if the amount of coverage is less than $50,000, the premiums paid for the benefit are non-taxable. However, if the amount is above $50,000, it is considered a taxable benefit.

Many employers have also resorted to using gift cards or property as part of an employee incentive strategy – typically seen as part of a retention program or for sales/performance incentives. Despite the fact the payment is not in cash, employers need to be aware that payments made via gift cards are considered cash equivalent and therefore should be considered taxable compensation and reported as such, including applicable withholding. Similar is true for items of personal property (think tablets or televisions); the value of these should be included in reported income. However, “small” promotional items (water bottles, T-shirts) do not fall into this category and are considered de minimis fringe benefits.

One exception to the above relates to employee retention programs. IRC Section 74(c) allows for employees to exclude tangible property valued up to $1,600 (not including cash, cash equivalents, meals, vacations or event tickets) for either a safety achievement or for length of service (must be at least 5 years of service to start and can only be every 5 years thereafter). Further, it must be presented as part of a “meaningful presentation.”

Beyond the above, examples of taxable benefits can include:

• Gym membership
• Housing allowances
• Moving expenses (post 2017 tax reform)
• Employer provided transportation (post 2017 tax reform)
• Certain stock-options and restricted stock
• Certain employer provided meals

Other forms of non-taxable benefits can include:

• Adoption Assistance Programs
• Tuition/Student Loan Assistance Programs
• Dependent Care Assistance Programs
• De Minimis Fringe Benefits

Many of the above have dollar limitations on their value and require compliance (a written plan document) and non-discrimination testing. Tuition and Student Loan assistance is available under IRC Section 127 and is limited to $5,250 per year. Dependent Care Assistance is limited to $5,000 per year (2021 had a temporary increase) and are typically (but not always) funded via a “cafeteria” plan which is an employee salary reduction arrangement. A de minimis fringe benefit is a “low cost” perk for employees that is considered administratively impractical to account for, such as occasional use of the copier, snacks, small holiday gifts or personal use of cell phones provided for business.

Most of these non-taxable benefits are non-taxable because they are specifically excluded from tax by the internal revenue code – a crucial distinction. These are items of value that would otherwise be taxable if not for a specific exclusion. The key takeaway here is that items of value paid by an employer to an employee will be presumed taxable unless somehow specifically excluded.

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