Strengthening Employers' Hands: The ABCs of Tax Smart Fringe Benefit Program Design
Gildea, Elizabeth, Maydew, Gary L., The National Public Accountant
Perhaps no part of a firm's operations is of more interest to its employees than its compensation package. The amount and composition of the compensation will vary greatly, depending on the nature of the firm, the labor market in which it operates and the particular needs of the employees. Within this context, fringe benefits can play a critical role in increasing employee satisfaction. The purpose of this paper is to provide summary coverage of the various fringe benefits available under federal income tax law. Included are tables summarizing the tax status and major requirements of various fringe benefits.
Definition and Types of Fringe Benefits
The term "fringe benefits" is not defined in the income tax code. However, the phrase is generally understood to mean benefits provided by an employer to its employees (or others performing services for the employer) other than salary or wages for services rendered. These benefits may take many forms, including: cash payments; providing privileges, goods, services or facilities to employees; allowing employees to use employer property; providing intangible benefits (such as time off with pay); or giving employees the right to receive stock of the employer.(1) Although generally thought of as being tax-free, fringe benefits are excludable from income only if so specified by the tax code. Hence, some benefits are excludable for both federal income tax and FICA tax purposes, some are excludable only for federal income tax purposes and others are fully taxable.
Fringe benefits can be classified into three types: insurance benefits, deferred compensation plans and incidental benefits.
The benefit provided by the employer in this instance consists of the premiums paid on behalf of the employees. If the fringe benefit meets excludability requirements, neither the value of the premium payment made by the employer, nor the benefit payments made by the insurance company are taxed to the employee. Insurance benefits to be discussed here are group-term life, ordinary whole-life insurance policies, health and accident insurance, and legal services insurance.
Premiums paid by the employer on the first $50,000 of group term life insurance coverage on the employee (spouses and dependents are not eligible) are excludable from income under Code Section 79. Coverage in excess of $50,000 is taxable after deducting all premium payments made by the employee. The plan must be in writing and must meet nondiscrimination requirements. To determine the taxable amount, the IRS publishes uniform premium tables that determine the cost per month per thousand broken into age groups.(2)
Ordinary whole-life policies are not an excludable fringe. Thus, if the employee is the owner of the policy and the employer pays the premiums, the premium payments must be included in gross income of the employee. If the employee is merely the insured, but the employer owns the policy (e.g., key-man life insurance policies), the employee has no income resulting from the policy.
Health & Accident Policies
If the employer pays premiums for a health and accident policy on the employee, his spouse and dependents (or makes trust fund contributions in self-funded arrangements), the employee may exclude the premium payments from income provided the plan is written and nondiscrimination rules are met. However, the tax status of the benefits depends on the type of benefit payment. Payments received for medical care and loss of a member or function of the body are excludable. Payments received for income reimbursement under disability plans are taxable (although workmen's compensation is excludable) to the extent that the employer has paid the premiums.
An employee may, under Code Section 120, exclude from gross income amounts contributed on behalf of the employee, spouse and dependents toward premiums on a group legal services plan as well as the value of legal services provided by the plan or amounts paid for legal services. …