Fringe benefits—things like health insurance, retirement plans, or company cars—are often considered a great way to attract and retain top talent. But when it comes to taxes, fringe benefits can be a minefield for business owners.
The problem? While fringe benefits are meant to offer value to your employees, they can also trigger unwanted IRS scrutiny if not structured and reported correctly.
Here’s what you need to know to avoid tax pitfalls and offer these benefits the right way.
What Are Fringe Benefits, Anyway?
Fringe benefits are non-wage compensations provided to employees in addition to their regular salaries or wages. These benefits can be either taxable or non-taxable, depending on the type and how they are structured.
Common examples include:
- Health insurance premiums
- Retirement contributions
- Life insurance
- Company vehicles
- Educational assistance programs
- Employee discounts
However, the line between what is a taxable and a non-taxable benefit isn’t always crystal clear.
Pitfall #1: Misclassifying Non-Taxable Benefits
The IRS allows certain fringe benefits to be provided to employees without triggering additional taxes. These include benefits like health insurance, group-term life insurance, and some employer-provided meals.
However, many business owners mistakenly assume that all benefits fall into this “non-taxable” category. For example, if you provide an employee with a cell phone for work, it may seem like a small benefit. But unless the phone is used primarily for business purposes, it could be subject to taxation.
The Risk: Misclassifying taxable fringe benefits as non-taxable could lead to an audit. The IRS will reclassify those benefits, charge back taxes, and impose penalties.
Pitfall #2: Failure to Track Benefit Usage Properly
When offering fringe benefits like a company vehicle or an employee discount, you must track how these benefits are used. For example, if your employee uses a company car for personal trips, that could trigger tax liability.
For employees who use the company car or other items for personal use, you must calculate the fair market value of the personal use and report it as income on their W-2 forms.
The Risk: If the IRS audits your business and finds that personal use was not tracked or reported correctly, you could face fines and penalties. The key here is accurate record-keeping.
Pitfall #3: Offering Benefits That Don’t Fit Your Business Structure
Not all fringe benefits are appropriate for every business. For instance, small businesses that are set up as sole proprietors or LLCs may not be able to offer certain benefits, like tax-advantaged retirement contributions, without triggering unintended tax consequences.
Similarly, offering health insurance or life insurance may not be beneficial unless structured properly—especially if you are self-employed or running a small business without employees.
The Risk: If you offer fringe benefits that don’t align with your entity structure, you could be wasting money or creating unnecessary tax obligations.
How to Offer Fringe Benefits Without the Audit Risk
The key to offering fringe benefits safely is to:
- Understand the taxability rules: Educate yourself on the types of benefits that are taxable and non-taxable. Work with a tax professional to ensure you’re on the right track.
- Track usage carefully: If your employees use any company-provided benefits for personal reasons (like a company car), track that usage and report it accordingly.
- Be aware of your business structure: Tailor your fringe benefits to fit the structure of your business. What works for a corporation may not work for an LLC or sole proprietorship.
The Bottom Line: Don’t Let Fringe Benefits Lead You Into Trouble
Fringe benefits are a great tool for attracting and retaining talent, but they come with the risk of costly mistakes if you don’t know the rules. By understanding the tax implications and structuring your benefits properly, you can offer valuable perks to your employees without risking an IRS audit.
Want help navigating fringe benefits?
Book a consultation with us today to get personalized advice on how to structure and report your benefits correctly—and avoid costly tax mistakes. Click on Contact in the top right corner to get started!
