Imputed Income and Fringe Benefits: A Detailed Guide
The lion's share of employee compensation comes in the form of a paycheck, but not all of it does. Companies will often try to entice workers through non-financial means, such as company cars, gift vouchers, or free use of local gyms.
These perks are often referred to as imputed income and fringe benefits. They’re extra goodies on top of basic pay that make the job more attractive. There are also some differences between the two that you should be aware of.
In this post, we’ll take a look at both fringe benefits and imputed income and talk about what’s included and excluded from each. We’ll also show you how to calculate imputed income and give some examples of non-taxable fringe benefits.
What Is Imputed Income?
Defining imputed income is straightforward: it's the money that employees receive that isn’t a part of their salary or wages but is still taxable income. The employee doesn’t pay directly to receive the benefits – the company does that – but they still need to declare this value to the IRS.
Examples of Imputed Income
There are multiple examples of remuneration items that the IRS considers as imputed income. These include:
- Group term health insurance policy if its value exceeds $50,000
- Any employer care money that exceeds the tax-free allowance
- Wellness incentives (such as paying gym memberships)
- Personal use of company vehicles (not just ones used for work)
- Employee discounts
- Training, development and educational spending that exceeds the tax-free employee allowance
- Reimbursements for non-deductible relocation expenses.
What Is Excluded from Imputed Income?
Certain imputed benefits are not included in imputed income. For instance, health insurance for dependents, health savings accounts, and dependent care assistance under $5,000 are all tax-free. Group term life insurance is also tax-free under $50,000 as is education assistance under $5,250 per year.
What are Fringe Benefits?
Fringe benefits are benefits that employees receive on top of their regular salary. They can take the form of bonuses, insurance policies, goods, and services paid for by the employer as part of the employee’s compensation package.
The difference between fringe benefits and imputed income is semantic. Fringe benefits refer to the actual benefits themselves, such as company car ownership or free gym membership, while imputed income refers to the technique used to describe the monetary value of those benefits.
For calculating gross taxable income, the latter is what matters, while the former is primarily of interest to the person taking the job.
Legally Required Fringe Benefits
Fringe benefits that companies are expected to deliver to their employees depend on the company size and the number of its full-time employees. Rules vary according to state, but virtually all firms need to supply workers' compensation, health insurance, unemployment insurance, and family and medical leave.
If you are not sure whether you need to provide these fringe benefits, consult with a professional or look at the laws in your state. Make sure that you check both local and state-level laws, just in case there are specific requirements in your area.
Imputed Income and Taxes
In most cases, employers will need to add an employee’s fringe benefits (in addition to any tax-free allowances) to their gross taxable salary or compensation. Imputed income is not added to net income since that would suggest that it has already been taxed, which it hasn’t.
Employers, therefore, need to complete a W-2 form for tax purposes. This declares that fringe benefits are calculated as imputed income. Imputed income is usually subjected to Medicare and Social Security taxes, but not federal income tax withholding.
How To Calculate Imputed Income
When businesses offer employees fringe benefits, they need to calculate employees’ imputed income. To do this, companies should use “fair market value.” They can do this by looking at how much they paid for the benefits they offered to employees.
For IRS purposes, “fair market value” refers to whatever a willing buyer would pay for an item of equal value. For instance, if you get a gym membership for your employees at $50 per month, then the fair value would be the same since that’s what other members of the public would pay, too.
If you’re stuck, the IRS provides information on fair market value in its Fringe Benefits Guide. Here, you can see what the tax authority thinks various items are worth.
In some cases, you may be able to negotiate lower prices with third-party vendors by ordering bulk services for all your employees. Individual gym membership, for instance, might be $50 per month, but if you have twenty qualifying employees, that might fall to $40 per month.
To calculate fringe income, adhere to the following steps:
Find De Minimis Fringe Benefits and Exclude Them
Finding and eliminating de minimis (minimal) fringe benefits is the first step for most brands. It involves excluding all the small benefits employees receive from your company, such as free coffees at work, that the IRS does not consider taxable.
To check whether you need to add any particular item as a fringe benefit, check the IRS Publication 15-B. It lists many items you don’t have to include in gross taxable pay.
Here are some examples of non-taxable benefits that do not have any consequences on imputed income:
- Birthday or vacation gifts worth less than $100
- Company swag such as backpacks, bottles, pens, and T-shirts
- Free company food, such as company picnics
- Flowers and fruit baskets for special occasions
- Use of company copy machines for personal reasons
- Occasional tickets to sporting events, concerts, and art exhibits.
In many cases, you can use your personal judgment. If the IRS does not mention an item on Publication 15-B and it is worth less than $100, it is unlikely that you will need to include it in your imputed income estimates.
Calculate the Value of Employee Fringe Benefits
Most companies use the General Valuation Rule when processing fringe benefits. This attributes fair market value to each item added to the employee’s compensation package, in addition to their basic pay.
Once you have all of the fair market values, you simply add them up. This gives you the total value of the fringe benefits company-wide.
Calculate Business Use Percentages
The next step is to calculate what percentage of the fringe benefits the employee consumes for personal use.
Let’s say that you gave an employee a laptop when they joined your firm to do their job. If they use the equipment exclusively at work, you can subtract the expense from their imputed income. That’s because it is not providing the employee with any private gain. However, if the worker splits the use of the laptop equally between work and leisure, then you can only subtract half of its value from their imputed income. The rest must be taxed.
Subtract Allowances and Exemptions
As discussed above, some types of fringe benefits are exempted from taxes up to a certain amount - anything over that will get taxed. If the imputed income is less than the tax threshold for each category, the employee pays no additional tax. If it is more, they’ll only pay tax on the surplus above the threshold.
For instance, the IRS currently allows companies to go tax-free for up to $5,250 per employee for the purposes of educational expenses. Therefore, if an employee receives $7,000 in education-related fringe benefits, their imputed income (on which they must pay tax) will be $1,750.
Record All Fringe Benefits On Your Payroll
To get the gross income, your employee would have to pay taxes on you’ll add their fringe benefits or imputed income to their salary. For instance, you might provide a salary of $3,000 per month and an additional net imputed income of $750 per month.
Therefore, the employee’s gross income for federal and state taxes, Medicare, and Social Security deductions would be $3,750.
To avoid employees having to file and pay fringe benefit taxes out of pocket, you should send the IRS some money out of their paycheck every month to build a positive balance. To calculate how much to contribute, multiply the taxable value of fringe benefits by the tax rate and divide it by the withholdings rate.
Put Imputed Income on Your Pay Stubs
Some employees will ignore the imputed income line entry on their pay stub, but many will want to see how much compensation they receive in the form of fringe benefits.
That’s why it’s a good idea to put all of the benefits of imputed income on your pay stubs. This way, employees can see what you’re giving them and calculate their tax withholdings more easily.
If you’re stuck, experts recommend using software to take care of employee payroll and imputed income calculations. Developers regularly update their solutions with the latest rules and guidelines from the IRS, allowing you to automate many tedious accounting operations.
Should You Use Travel and Entertainment Expense Management for Fringe Benefits?
Companies can approach fringe benefits in one of two ways. Either they can pay for them directly on behalf of workers, or they can get workers to pay first and then reimburse them later on.
If firms opt for the latter option (getting employees to pay first), they often rely on travel and entertainment expense management (T & E). From the IRS’s perspective, any income employees derive from T & E reimbursements is exactly the same as taxable pay and, therefore, subject to tax.
What’s nice about T & E is that it pre-quantifies the value of the benefit. The moment the employee pays for it, the “fair value” of the item is revealed.
For instance, if an employee takes advantage of a company perk by joining a gym for $50 per month and then gets reimbursement from their employer, the firm doesn’t have to calculate fair value. Instead, it simply adds the dollar amount of the monthly membership cost to the employee’s imputed income.
The T & E approach also offers other benefits for employers. For instance, the system allows you to check company policy adherence. If an employee goes above their allowance, you can simply deny them access to more benefits.
You might want to cover many perks under T & E. Some are taxable, and others aren’t. For instance, moving reimbursements under 50 miles are taxable, while those over 50 miles are not. Personal use of a company car on a business trip is a taxable expense, but commuting benefits, up to a predefined IRS limit, are not.
The Bottom Line
Imputed income and fringe benefits are an important part of the modern labor market. They often allow companies to compensate their employees for time and effort beyond what would be possible through regular financial remuneration.
Employees love fringe benefits too. It makes them feel more like they’re a part of a community and gives them something extra as a reward for their hard work. They are well worth considering, but you need to understand how the IRS handles them to avoid getting yourself or your employees in tax trouble.
What is included in imputed income?
There are many fringe benefits that companies must list as imputed income. These include gym memberships, employee discounts in stores, group life insurance worth over $50,000, and the value of company vehicles if they are ever used outside of performing job-related tasks.
Does taxable income include fringe benefits?
Unless exempt, taxable income does include fringe benefits. After making deductions, employers must add the value of imputed income to gross taxable income and increase the employee’s tax payment to the IRS accordingly.
Is imputed income considered earned income?
Imputed income and fringe benefits are a type of earned income because even as a form of non-monetary compensation, these perks are offered by employers in exchange for work. Companies could simply pay their employees to cover the cost of their fringe benefits, but it often works out as better value for everyone if employers cover these costs themselves and then record them as imputed income.
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