2023 Year-End Reminders Regarding Common Fringe Benefits, Special Rules for 2% S Corp Shareholders
As 2023 draws to a close, employers should review whether they have properly included the value of common fringe benefits in their employees’ and (if applicable) 2% S corporation shareholders’ taxable wages. This is especially true for 2023 and beyond, as many employers continue to deal with remote or hybrid workforces.
Fringe benefits are defined as a form of pay for performance of services a company provides to its employees as a benefit; the value of those benefits must be included in an employee’s pay unless specifically excluded by law. The actual value of the fringe benefits provided must be determined annually before December 31 to allow for the timely withholding and deposit of payroll taxes. Failure to properly report includible fringe benefits to the recipient and the IRS on Form W-2 or Form 1099 before January 31, 2024, may result in penalties. Employers have the burden of proving that tax-free treatment of fringe benefits was appropriate.
This alert provides a review of the rules on the identification of and tax reporting requirements for several fringe benefits that employers typically offer to their employees.
Remote Workforce Fringe Benefits
Common Employee Fringe Benefits
Employer-Paid Educational Assistance
PTO Leave Donation
Many people are now working from their personal residence and have greater flexibility to spend time on personal matters without being charged for paid time off (PTO). Even routine doctor visits require less time off due to the widespread availability of virtual, on-line services. At the opposite end of the spectrum, essential employees might not have PTO approved because there is no one to perform their duties while they are away. For these and many other reasons, employees are taking fewer PTO days and therefore are at risk of forfeiting some of their accrued PTO.
While most employers hate to see employees forfeit earned PTO, there is no single approach to avoid this situation that is agreeable to all employees. Mandatory cash-outs are not always well received, because every employee has a different plan for PTO usage. Voluntary cash-out programs can have unexpected tax consequences to employees that prefer to keep their PTO for future use.
As an alternative to forfeiting excess PTO accruals, some employers facilitate donation of unused PTO either to charity or to other employees who need it.
Personal Use of Company Car
The value of a company car used for personal travel must be treated as additional wages at a frequency chosen by the employer--up to and including on an annual basis--unless the employee reimburses the employer for such personal use.
FIT withholding on fringe benefit wage additions can be calculated as a combined total with regular wages or generally can be withheld at a flat 22% supplemental wage rate if the employee earns under $1 million.
Alternatively, employers can choose not to withhold FIT if the employee is properly notified by January 31 of the year in which imputed income for personal use of a company car will arise or 30 days after a vehicle is provided and the value is properly reported on a timely filed Form W-2. But employers must withhold FICA taxes on such benefits.
For administrative convenience, an employer can calculate the value of personal use of a company vehicle for the current year based on the 12-month period beginning November 1 of the prior year and ending October 31 of the current year (or any other 12-month period ending in November or December) if the employee is properly notified no earlier than the employee’s last paycheck of the current year and no later than the date the Forms W-2 are distributed. Once this valuation period is elected, the same accounting period generally must be used for all subsequent years with respect to the same automobile and employee.
Many companies have moved away from providing company cars and instead make cash payments to reimburse employees for the business use of their personal vehicle. Car allowances paid in cash without any substantiation of business use are fully taxable and subject to FICA, FUTA, FIT, and SIT withholding.
Personal Use of Company Aircraft
This fringe benefit (unless reimbursed by the employee to the extent permitted under FAA rules) is subject to FICA, FUTA, FITW, and SITW. The value of the benefit is calculated based on the Standard Industry Fare Level formula provided by the IRS. Expenses related to personal entertainment use by officers, directors, and 10%-or-greater owners that exceed the value treated as compensation to key employees are nondeductible corporate expenses.
Benefits That Exceed De Minimis Exclusion
De minimis benefit amounts can be excluded when the benefit is of so little value (taking into account the frequency) that accounting for it would be unreasonable or administratively impractical. It is a common misconception that if a fringe benefit amounts to less than $25, it is automatically considered a de minimis benefit. However, there is no statutory authority for this position.
If a fringe benefit does not qualify as de minimis, generally the entire amount of the benefit is subject to income and employment taxes (FICA, FUTA, FITW, and SITW). Season tickets to sporting or theater events, use of an employer’s residence, apartment, boat or vacation home, and country club or athletic facility memberships do not qualify as de minimis benefits. De minimis benefits have never included cash, gift cards or certificates, or cash-equivalent items, regardless of their amount. Gift cards or certificates that cannot be converted to cash and that are otherwise a de minimis fringe benefit redeemable for only specific merchandise such as a ham, a turkey or another item of similar nominal value might be excludable from income. However, gift cards or certificates that are redeemable for a wide variety of items are deemed to be cash equivalents. Any portion of a gift card or certificate that is considered a cash equivalent should be included in the employees’ Forms W-2 and subject to income and employment taxes as detailed above.
While snacks and meals provided to employees can meet the de minimis requirements, they often do not. Still, most employer-provided meals are excluded from the employees’ taxable income under the accountable plan rules for working condition fringe benefits. The employer’s deduction for these meals generally is limited to 50% of food and beverage expense for quiet business meals with customers and clients (i.e., no entertainment is involved). Under special COVID relief designed to help the restaurant industry for 2021 and 2022 only, employers can generally deduct 100% of business meals purchased from a restaurant if the business owner or an employee is present when the meal is provided and the expense is not lavish or extravagant. That special rule was not available in 2023 and beyond. Entertainment expenses, even with a business purpose, generally are not deductible. But food or beverage expenses related to employee recreation, such as holiday parties or annual picnics, are fully deductible when provided primarily for the benefit of rank-and-file employees.
Caution: We have seen the IRS take an aggressive position on examination, with the agent proposing that the company expenditure for on-site food and beverages regularly furnished to employees should be treated as employee compensation because it is too frequent or extravagant to be excludible as a working condition or de minimis fringe benefit.
Employee Achievement Awards, Gifts and Prizes
This fringe benefit is subject to FICA, FUTA, FITW, and SITW. In general, employee achievement awards, gifts, and prizes that do not specifically qualify for exclusion are deductible by the employer only up to $25 per person per year, unless the excess is included as taxable compensation to the recipient. Any gifts to employees in excess of $25 per person per year in the form of tangible or intangible property are taxable wage income for employees. There are two exceptions to the general rule: (i) achievement awards for length of service or safety and (ii) certain non-cash achievement awards, such as a gold watch at retirement or nominal birthday gifts, which fall within the exclusion for de minimis benefits.
For a length of service or safety award to be considered excludible, there must be a meaningful presentation of the award, the employee being recognized must have at least five years of service, and the award cannot have been granted to the same employee in any of the prior four years. The exclusion applies only for awards of tangible personal property and is not available for awards of cash, gift cards, or certificates or equivalent items. The exclusion for employee achievement awards is limited to $400 per employee for nonqualified plans (unwritten and discriminatory plans) or up to $1,600 per employee for qualified plans (written and nondiscriminatory plans).
Job-Related Moving Expenses Paid by Employer
Moving expenses incurred during 2023 that are paid by an employer must be included in the employee’s taxable compensation unless the employee is an active duty member of the U.S. Armed Forces and is moving to a permanent change of station. The exclusion from employee income is scheduled to be reinstated on January 1, 2026. Employers can still pay (and obtain a deduction for paying) employee moving expenses, but those amounts are now taxable wages paid to the employee, due to the changes in the law made by the Tax Cuts and Jobs Act (TCJA) of 2017.
Qualified Transportation Fringe Benefits
Employers cannot deduct expenses incurred in providing qualified transportation fringe benefits to employees. Tax-free transportation fringe benefits may still be provided to employees, but the employer will not get a deduction for providing such tax-free benefits. The 2020 final regulations on how to calculate the disallowed deduction for employee qualified transportation costs include some helpful positions and simplified methodologies on how to determine the cost of employee parking. For example, parking in some remote areas may be treated as having no value, so the deduction is not disallowed. The payroll tax treatment of employee parking, van pool, and mass transit benefits remains unchanged.
Qualified commuting and parking amounts provided to the employee by the employer in excess of the monthly statutory limits are subject to FICA, FUTA, FITW, and SITW. For 2023, the statutory limits are $300 per month for qualified parking and $300 for transit passes and van pooling. An employee can be provided both benefits for a total of $600 per month, tax-free, with the excess included in Form W-2. For 2024, the limits increase to $315 (for a combined maximum total of $630). Amounts exceeding the limits cannot be excluded as de minimis fringe benefits.
Caution: Mileage reimbursement to employees is not excludable as a qualified transportation fringe benefit and must be a working condition fringe benefit to avoid taxation.
For 2018 through 2025, bicycle commuting benefits that are qualified transportation fringe benefits are included in taxable wages subject to FIT, FITW, FITA, and FUTA. Because these benefits are taxed to the employee as regular compensation, the benefits are deductible by the employer.
The value of any de minimis transportation benefit provided to an employee can be excluded from Form W-2. For example, an occasional taxi fare home for an employee working overtime or departing a business function such as a holiday party may be provided tax-free.
Please note that some local jurisdictions require employers to provide mass transit options. For instance, the District of Columbia requires employers with 20 or more employees to offer qualified transit benefits. While D.C. employers are not necessarily required to subsidize the cost of their employees’ commuting expenses under the law, they are required to provide the option for employees to make a pre-tax election to take full advantage of the maximum statutory limits for transit, commuter highway, or bicycling benefits. San Francisco and New York City have adopted similar laws in an attempt to promote the use of available mass transit options and to reduce automobile-related traffic and pollution. Employers should confirm that they are in compliance with local requirements regarding mass transit options for each employee location.
Noncompensatory Cell Phones (and Other Devices)
The value of the business use of an employer-provided cell phone (and other communications devices) provided primarily for noncompensatory business reasons is excludable from an employee's income as a working condition fringe benefit. If the cell phone, tablet, or other device is provided to the employee as a “welcome aboard” or other bonus, and the item is not linked to the employer’s business, the fair market value of the item is treated as imputed taxable compensation to the employee.
Personal use of an employer-provided cell phone given to the employee primarily for noncompensatory business reasons is excludable from the employee's income as a de minimis fringe benefit. Employers provide a cell phone primarily for noncompensatory business purposes if there are substantial business reasons for providing the phone. Examples of substantial business reasons include the employer's need to contact the employee at any time for work-related emergencies, the requirement that the employee be available to speak with clients at times when the employee is away from the office, and the need to speak with clients located in other time zones at times outside the employee's normal workday.
Employers cannot exclude from an employee's wages the value of a cell phone or tablet or other device provided to promote the goodwill of an employee, to attract a prospective employee, or as a means of providing additional compensation to an employee.
Special Rules for Taxing Certain Employee Fringe Benefits to 2% S Corporation Shareholders
Certain otherwise excludable fringe benefit items are required to be included as taxable wages when provided to a 2% shareholder of an S corporation or of an LLC that elects to be taxed as an S corporation. A 2% shareholder is any person who owns, directly or indirectly, on any day during the taxable year, more than 2% of the outstanding stock or stock possessing more than 2% of the total combined voting power of the corporation. These fringe benefits are generally excluded from the income of other employees but are taxable to 2% S corporation shareholders similar to the way they are taxed if received by partners. If these fringe benefits are not included in the shareholder’s Form W-2, they are not deductible for tax purposes by the S corporation. The disallowed deduction creates a mismatch of benefits and expenses among shareholders, with some shareholders paying more tax than if the fringe benefits had been properly reported on Form W-2.
Taxable Fringe Benefits
The following describes fringe benefits paid for by an S corporation that are includable in the 2% shareholder’s taxable income.
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