Many business owners whose companies offer fringe benefits ask, “Can I participate in my organization's fringe benefits programs?”
Understanding how fringe benefits work for business owners can be challenging. While fringe benefit programs are primarily designed for your employees, there are cases where business owners can participate. This depends on your tax filing status, the type of organization you own, and the individual fringe benefits you offer.
This article explains how owners and their family members can determine if they can use fringe benefits.
Fringe benefits are offered on top of an employee's regular salary as part of a benefits package. While the term fringe benefits can apply to all employee benefits, we'll focus on the benefits listed in IRS Publication 15-B1.
Common fringe benefits include expense reimbursements, health benefits such as health reimbursement arrangements (HRAs), and employee stipends.
Other examples of fringe benefits include:
Offering additional fringe benefits is an excellent way to increase employee satisfaction and reduce employee turnover. While some fringe benefits are voluntary, others are required by law. Federal benefit requirements include health insurance for organizations with 50 or more full-time equivalent employees (FTEs) and unemployment insurance. Some states may also require disability insurance, retirement plans, and workers' compensation insurance.
Fringe benefits are generally considered taxable unless the IRS or federal law specifically excludes a particular benefit from taxes.
Sometimes, employers want to participate in the same benefits programs as their employees. With many types of popular fringe benefits, you can easily participate on a taxable basis. However, there are limitations on which types of business owners can use these additional benefits on a tax-free basis.
A C-corporation is a legal entity separate from the owners. Therefore, owners of a C-corp are considered employees. A corporation owner, their spouse, and their dependents are eligible for fringe benefits. This also applies to limited liability companies that elect to be taxed as a corporation instead of a partnership.
Taxable fringe benefits and stipends must be reported on an owner's Form W-2 as income, while tax-advantaged benefits are excluded from income.
C-corp owners are eligible to participate in almost all types of fringe benefits, including HRAs.
An S-corporation, or S-corp, is a business that isn't subject to corporate income tax. Instead, every shareholder who owns 2% or more of the organization is taxed.
An owner with 2% or more of the company's shares, their spouse, and dependents can use taxable fringe benefits with some special rules. Since S-corp shareholders aren't employees and are instead considered self-employed, the value of the fringe benefits must be reported as additional taxable income on IRS Schedule K-1 (Form 1065) in the Partner's Share of Income, Deductions, Credits, etc. section.
Partners (and owners of a limited liability company who are taxed as a partnership), sole proprietors, and S-corp shareholders who own at least 2% of shares all have the same rules regarding IRS Publication 15-B benefits.
Partners' taxable income from the fringe benefits is reported on Schedule K-1. Partners aren't eligible for many tax-advantaged benefits, but there are exceptions.
While most fringe benefits are taxable for S-corp and partnership business owners, there are a few exceptions. There are various tax-free fringe benefits available to employers and employees.
Tax-free benefit options for partners and S-corp shareholders include:
Partnerships and S-corps can pay for job-related education expenses and deduct the total cost tax-free. However, educational assistance programs limit how much you can contribute to owners and their dependents.
Some fringe benefits are taxable to all employees, while others are taxable to business owners. You must report the total amount of any taxable fringe benefits and withhold federal income tax, Social Security, and Medicare.
Here's a list of fringe benefits that are taxable for employers:
Other benefits, such as employee stipends, are taxable for both employers and employees.
A health stipend allows you to provide a payment card or reimburse your employees (and yourself) for medical expenses such as health insurance premiums and out-of-pocket healthcare expenses. This is an excellent option for organizations with independent contractors and international workers, as those employees are eligible for the benefit.
A wellness stipend is another popular taxable employee stipend. This allows you to give your employees money for their wellness expenses, such as gym memberships, fitness classes, wearables and devices, home exercise equipment, and more.
If you or your employees work from home, you can offer a remote work stipend to help employees cover their home internet access costs, cell phone bills, and home office setup costs.
There are some fringe benefits that S-corp shareholders, partners, and sole proprietors are ineligible for.
Partners and 2% shareholders aren't eligible to participate in a tax-advantaged Section 125 cafeteria plan, such as a health savings account (HSA) or flexible spending account (FSA). However, you can still participate in these plans on a taxable basis. Owners can't treat cafeteria plans as a reduction in distributions.
For HSAs in particular, partners and S-corp shareholders aren't eligible for pre-tax contributions. Instead, treat contributions as distributions or guaranteed payments.
S-corp owners and partners are ineligible to receive tax-free reimbursements through an HRA. However, a partner can receive tax-free reimbursements if their spouse is a W-2 employee of the organization.
According to the IRS, most organizations use the general valuation rule to determine the value of fringe benefits for federal income tax purposes. This is based on the fair market value (FMV), which is how much an employee would have to pay a third party to buy or lease the benefit.
It's important to remember that neither the value an employee or employer perceives in the benefit nor the amount you paid for the benefit is considered FMV.
You must report this amount on W-2s and to the IRS by January 31 of the following year.
For federal income tax withholding, the IRS allows you to use a flat 22% rate on the FMV of fringe benefits. You must also withhold a 1.45% rate for Medicare and an additional 0.9% on any amounts above $200,000 in total wages to an employee or employer.
Many fringe benefits enable business owners to take advantage of their benefits packages. While most benefits are taxable to S-corp shareholders, partners, and sole proprietors, a few exceptions allow you to make the most of whatever type of fringe benefits you choose to offer.
If you're looking to offer tax-free health benefits, PeopleKeep can help! Our HRA administration software allows organizations to set up and manage their health benefits in minutes.
This article was originally published on June 27, 2022. It was last updated on May 25, 2023.
1. https://www.irs.gov/pub/irs-pdf/p15b.pdf