Key Takeaways

  • Fringe benefits are non-wage compensations employers provide, such as health insurance, company cars, or educational assistance.
  • They may be taxable or tax-exempt depending on IRS rules, fair market value, and how they are structured.
  • Employers use fringe benefits to attract and retain talent, boost morale, and remain competitive in hiring.
  • Common tax-exempt benefits include health plans, retirement contributions, commuter benefits, and certain employee discounts.
  • Employers must correctly report taxable fringe benefits, and employees must include them in income when required.
  • Different categories exist: legally required benefits, voluntary benefits, and “perks” that enhance workplace culture.

Fringe Benefits

Fringe benefits are defined as those benefits an employer makes available to any employee, partner, or independent contractor. Fringe benefits are treated as compensation in addition to any wages or salaries. For example, access to a company car, housing allowance, medical insurance, pension plan, and paid holidays would all be viewed as fringe benefits. Certain fringe benefits may be exempt from taxation if specific conditions are met. If you are a recipient of any taxable fringe benefits, you must include the benefit’s fair market value in your annual taxable income calculation. Taxable fringe benefits are subjected to all federal income taxes, as well as FICA and FUTA.  Non-fringe benefits are not subject to any of the aforementioned taxes. Any benefits that an employer offers to an employee in return for services rendered would be classified as a fringe benefit.

Competitive fringe benefits are generally offered to employees with the intent of attracting job seekers. In fact, one study revealed that 25.2 percent of respondents indicated that quality of employee benefits was very important to them. While 31.2 percent viewed employee benefits as moderately important, 33.8 percent viewed employee benefits as somewhat important, and only 9.8 percent stated that employee benefits were not important. 

In the not too distant past, employers started to realize that prospective employees attribute great weight to salary being offered for the position. In an attempt to lure qualified individuals to the company, rather than considering a competing offer, employers started to offer non-salary compensation in addition to the actual salary compensation.

Purpose and Advantages of Fringe Benefits

Fringe benefits serve more than just financial purposes. Employers offer them to remain competitive in the job market, improve employee retention, and enhance overall workplace satisfaction. For employees, fringe benefits can provide access to services or resources that would otherwise be costly, such as health insurance or retirement savings plans. Businesses also gain tax advantages when offering certain benefits, as many are deductible as business expenses. In addition, companies that provide robust fringe benefits often see higher productivity and lower turnover rates, since employees feel valued and supported.

Breaking Down ‘Fringe Benefits’

Within the classification of fringe benefits, an employee can commonly expect to find educational assistance, group-term life insurance coverage, health insurance coverage, childcare assistance reimbursement, employee stock option plans, and others.  As previously mentioned, a fringe benefit may be classified as tax-exempt based on the type of benefit as well as the benefit value. That said, the default position remains that all fringe benefits are subject to taxation unless the benefit has been specifically classified as tax-exempt.

Types of Fringe Benefits

Fringe benefits can be grouped into several categories:

  • Legally Required Benefits: Social Security contributions, Medicare, unemployment insurance, and workers’ compensation.
  • Insurance Benefits: Health, dental, vision, and group-term life insurance coverage.
  • Retirement and Savings Plans: 401(k), pensions, and profit-sharing plans.
  • Lifestyle and Convenience Benefits: Company cars, housing allowances, free meals, childcare assistance, fitness memberships, and commuter benefits.
  • Professional Development: Tuition reimbursement, educational assistance, training, and certification programs.
  • Equity and Incentive Plans: Stock options, restricted stock units (RSUs), and performance bonuses.

Employers may also provide “perks” such as remote work stipends, mental health services, or wellness programs. The exact mix often depends on company culture and industry standards.

Tax-Exempt Benefits

There are several examples of fair market value. Fair market value is defined as the price an employee would pay for the same benefit if he/she were to engage in a transaction with a third party. To calculate fair market value, any relevant factors must be considered, such as geographic location as well as current market conditions. The actual cost of providing the benefit to the employee may be different than the benefits fair market value.

The calculation used to value the usage of a company automobile is slightly more complex. One may use fair market value. In addition, if the automobile could have been part of a leasing program based on a cent per mile basis, the miles driven in the automobile may be multiplied by the standard rate per mile allowed by the IRS.  

Taxable vs. Nontaxable Benefits

While many fringe benefits can be offered tax-free, others are taxable and must be included in the employee’s gross income.

Taxable benefits may include:

  • Personal use of a company vehicle
  • Club memberships or gym stipends not structured as wellness programs
  • Housing allowances (unless required for the job)
  • Cash bonuses and gift cards

Nontaxable benefits may include:

  • Health insurance premiums paid by the employer
  • Employer contributions to retirement accounts
  • Commuter benefits (up to IRS limits)
  • Employee discounts within IRS thresholds
  • Educational assistance (up to $5,250 per year)

Employers must determine the fair market value (FMV) of taxable benefits and report them on Form W-2. Employees, in turn, are responsible for including taxable amounts in their income. IRS Publication 15-B provides detailed guidance on how to classify and report these benefits.

Reporting and Compliance

Employers are required to properly identify, value, and report fringe benefits to remain compliant with tax laws. Reporting obligations vary depending on the type of benefit:

  • W-2 Reporting: Taxable fringe benefits must be reported as part of employee wages.
  • Payroll Taxes: Benefits subject to FICA and FUTA must be withheld accordingly.
  • Recordkeeping: Employers should maintain documentation on how the value of benefits is determined, especially when FMV estimates are used.

Failing to comply with IRS rules can lead to penalties, back taxes, and audits. For small businesses, consulting with a tax professional or legal advisor can ensure proper reporting.

Frequently Asked Questions

1. What are fringe benefits?

Fringe benefits are non-wage compensations, such as health insurance, retirement plans, and company cars, provided to employees in addition to salaries.

2. Which fringe benefits are tax-free?

Examples include health insurance, retirement contributions, commuter benefits, and educational assistance (within IRS limits).

3. Do employers have to offer fringe benefits?

Some, like Social Security, Medicare, and unemployment insurance, are legally required, while others are voluntary.

4. How are taxable fringe benefits reported?

They are valued at fair market value and reported on Form W-2, subject to federal income and payroll taxes.

5. Why do companies offer fringe benefits?

Employers use them to attract talent, reduce turnover, and improve employee satisfaction, often while gaining tax advantages.

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