It’s essential for employers to build a benefits package that will recruit and retain the best employees. But before you get started, you must understand how each type of benefit will impact you and your staff’s tax liability.
When you give employees fringe benefits like a gift card or a company car for personal use, they must pay taxes on the value of these perks. That’s because the IRS considers these benefits imputed income.
If you plan to offer your staff various fringe benefits, you need to know which ones are exempt from taxes. You also need to know how to properly report imputed income on an employee’s W-2 form.
In this blog, you’ll learn:
- The definition of imputed income and how it applies to fringe benefits.
- The tax implications of imputed earnings, including how to report it on W-2 forms.
- Examples of imputed income and which benefits are exempt.
Imputed income is the value of non-cash compensation employees receive from their employer. This form of income is outside of their regular wages or salary. Many fringe benefits and perks are taxable imputed income. Other employee benefits, such as health insurance and health reimbursement arrangements (HRAs), aren’t subject to income taxes.
If you offer certain fringe benefits to your employees, you must treat the imputed earnings as regular taxable income. You must also report the amount on your staff’s Form W-2s for tax purposes. For instance, if you give a current employee a $100 gift card for completing a major project, you must report that amount as imputed income.
In some cases, fringe benefits are tax-free or tax-advantaged. You should consult with a tax professional to determine the tax status of your employee benefits.
Even though some non-cash benefits count as imputed income and increase employees’ tax liability, they’re still a great way to compensate employees beyond their regular wages. That’s because voluntary perks and personalized benefits are becoming crucial to an employer’s compensation package.
In a McKinsey & Company survey, 78% of employers said they offer at least one voluntary employee benefit1. Even if these benefits are taxable, they help support your employees’ well-being, improve job satisfaction, and reduce turnover.
Unless the IRS considers it exempt, you must add imputed income to an employee’s gross income as taxable wages. You don’t include the amount in your employees’ net income because they received the benefit in another form.
You must also include it on your employees’ W-2 Forms for federal income taxes. We’ll discuss that in more detail later.
Generally, imputed income isn’t subject to federal income tax withholding. But it’s subject to Social Security taxes, federal unemployment taxes (FUTA), and Medicare taxes. Your employees can withhold a specific amount of tax to account for the imputed income throughout the year. Or, they can pay the total amount when filing their federal tax return.
In either case, let your employees know about the tax penalties they may face if they don’t withhold enough federal taxes on their imputed income.
Knowing what counts as imputed income is vital for correctly reporting your company’s taxes. Many fringe benefits are taxable depending on the value received by the employee. But other benefits are subject to taxes regardless of the value or monetary amount.
Some examples of items that the IRS considers imputed taxable compensation include:
The value of fringe benefits employees receive can also affect non-tax-related items. For example, depending on the state, imputed income can impact an employee’s child support payments. In this case, imputed income gives the judge a more precise view of a non-custodial parent’s actual income. This helps determine an accurate child support amount they should pay.
The IRS excludes some benefits from the imputed income category. Also called “de minimis benefits,” these perks hold so little value and tax impact that the IRS finds it impractical or unnecessary to record them2.
These exclusions include:
Under IRS regulations, any fringe benefit valued less than $100 is a de minimis benefit. Remember, a vital aspect of these perks is that they’re infrequent benefits. So, considering how often you provide them in addition to how valuable they are is crucial to determining if you have a de minimis fringe benefit.
In most cases, excluded de minimis benefits aren't subject to federal income, Social Security, Medicare, FUTA, or Railroad Retirement Tax Act (RRTA) taxes. You also don’t need to report them on your employees’ W-2s.
Except for excluded benefits, fringe benefits are subject to employment taxes. So, you must report them on each employee’s W-2 form at the end of the year. To do this, accurately track the value of each employee’s imputed income throughout the year, the same as regular wages.
To correctly report taxable benefits, you must determine the value of each benefit. For some perks with assigned values, such as group-term life insurance and educational benefits, this may be simple. But other taxable fringe benefits, like personal use of a company car, may require you to determine the fair market value.
You can report imputed income on Form W-2 for each applicable employee in Box 12 using Code C. You should also include the amount for imputed income in Boxes 1, 3, and 5.
You can record imputed earnings at any frequency as long as it’s not less than annually.
Period reporting options include:
You can change your reporting frequency as much as you like. But you must report by December 31 of the year your employees received their benefits.
Imputed income is something all employers should understand. Whether you run your payroll manually or use payroll software, you must track imputed income, report fringe benefits, and include the tax totals on your employees’ W-2s.
Because imputed income can be tricky, it’s a good idea to inform your employees of any penalties that may apply if they don’t have enough tax withholdings.
While our article is a good starting point for understanding imputed income, it’s for informational purposes only. Contact your tax advisor for official guidance or other tax advice if you have questions.
This article was originally published on August 3, 2022. It was last updated on October 21, 2024.
1. McKinsey - Health benefits survey