Payroll professionals discussed tips for distinguishing taxable and nontaxable fringe benefits during the American Payroll Association’s 40th Payroll Congress.
Among the guidance given were reminders that IRS documents are crucial resources for compliance guidance and that cash is always taxable to employees. The taxability of prizes, education assistance, and loans also was discussed.
When the nontaxable status of a fringe benefit is in question, turn to the Internal Revenue Code and IRS publications for guidance, said Fred Basehore, Senior Director of Payroll Tax and Compliance at Guidehouse. Basehore also is a member of Bloomberg Tax’s Payroll Advisory Board.
Everything that an employer provides to an employee is taxable income unless a provision says otherwise, Basehore said May 11.
“Why’s it called a 401k? Because it’s referencing the actual Internal Revenue Code,” he said. “We have a code section that tells us what we can exclude from income.”
Finding guidance about nontaxable benefits is likely to be simpler than trying to find language explicitly stating that a benefit is taxable, Basehore said. “When you look at things like Publication 15 and 15B, when you read those, it’s extremely rare that you’ll find a sentence that says ‘such and so is taxable.’”
Instead, assume that a benefit must be included in income if you cannot find guidance permitting you to exclude it, Basehore said. “That’s what the premise of all of this is going to be. We’re looking for the proof.”
De Minimis Fringe Benefits & Prizes
There is no actual value threshold for determining de minimis fringe benefits, Basehore said. Rather, it is a matter of whether the benefit is easy to keep track of—if it is unreasonable to track, even if it costs a fair amount, it is not taxable, he said. However, any benefit or prize that you can easily track is taxable to the employee.
It might seem counterintuitive to think that a $10 toaster and a trip to Hawaii could receive similar tax treatments, Basehore said. But if both were given away as prizes at an employee event, you would know the value of the gifts and who received the gifts, so they would be taxable, he said.
If an employee brought a guest who won a taxable prize, the item would be taxable to the employee, he said.
Basehore emphasized that gift cards are always taxable income, regardless of whether the employee redeems the card. “Anytime you give your employees cash, cash is always taxable,” he said.
When giving employees the option to choose between several prizes, ensure that all of the prizes are tangible, noncash items, Basehore said. If you add a gift card to the pool of prizes, all of the items become taxable because the employee had the option to receive cash.
Awards must meet certain conditions to be nontaxable, Basehore said.
For example, for a length of service award to be excluded from income, it must be awarded for at least five years of service and awarded in increments of at least five years, he said. “Maybe yours is every seven—seven, 14, 21, 28. But if your company gives out length of service awards every three years—three, six, nine, 12—that’s not going to cut it.”
A qualified length of service award also must be presented at a ceremony with at least two people. “Picture this. The boss walks into the office, closes the door, shakes your hand, hands you a watch, and says, ‘Thanks for being here for 24 years,’” Basehore said. “Is that a gathering of two or more? No, because you don’t count. Pull somebody in from the hallway.”
For job-related educational assistance to be excluded from income, it cannot be necessary for minimum requirements of the position, said Linda Werts, Regional Payroll Manager for Cargotec Holding Inc. There is no dollar limitation for educational assistance that is related to an employee’s current job.
Educational assistance that is not directly related to the employee’s job cannot discriminate in favor of highly compensated employees and cannot provide employees with the option of receiving cash, Werts said May 12. Employees also must be made generally aware that the program exists, as telling only a handful of employees could be considered discriminatory, she said.
The tax exempt limit for nonjob educational assistance is $5,250 annually, Werts said. Reimbursement amounts exceeding the taxable limit should be reported as income for the year in which they were paid. For example, if a class were to run from December 2022 to March 2023, and the classes were paid for in December, the amounts would be included in tax year 2022 reporting, she said.
Werts noted that expense reimbursements need to be offered under an accountable plan. “If you can’t prove that it’s being used for the intended, nontaxable purpose, then it is taxable,” she said.
Loans to Employees
Below-market loans are those offered to employees by employers with an interest rate below the federal interest rate, said Andy Garboden, Education Training and Enablement Manager for Check Technologies.
If the outstanding balance of all of an employee’s below-market loans reaches $10,000, the difference between the interest charged by the employer and the federal interest rate becomes taxable, Garboden said May 12. The taxable amount is subject to Social Security, Medicare, and federal unemployment tax, but not federal income tax.
If the loan is forgiven, the entire balance becomes income, and is therefore taxable for all employment taxes—including federal income tax—on the day the loan is forgiven, Garboden said.