Make Compensation Tax-Free: The IRS Tells You How

Well, my headline may overstate a little bit the subject matter of a new publication by the Internal Revenue Service. Recently, the IRS issued Publication 15-B, Employer’s Tax Guide to Fringe Benefits. (Click here for full publication) It is a handy summary of fringe benefits, focusing primarily on twenty types of fringe benefits (and variations thereunder) that are wholly, or partially, excluded from the income from most employees. Generally, the “excluded” benefits are exempt from income tax and, in most cases, are exempt from Social Security Tax, Medicare Tax and Federal Unemployment Tax. Table 2-1 on page 6 gives you a concise summary of the primary fringe benefits and the tax treatments.

What fringe benefits, under the appropriate circumstances, might be excluded from the employees’ income? Some of these are pretty well known. Quickly coming to mind are accident and health benefits; health savings accounts; limited moving expense reimbursements: up to $50,000 of group term life insurance; and de minimis benefits, such as holiday parties, low value holiday gifts (other than cash), occasional personal use of the copying machine or printer, and occasional meals (within limits).

Some excludable fringe benefits may not be as obvious or as widely provided, but can be quite valuable to employees. Some examples include educational assistance, adoption assistance, dependent care assistance, athletic facilities, retirement planning assistance, commuting benefits, and employer-provided cell phones.

Other excludable fringe benefits are a bit more employer-type specific, such as lodging on business premises, employee discounts, and no-additional-cost services (think airline and hotel employees).

Some employees are not eligible for all of types of tax free benefits. In many cases of these fringe benefits, “2% shareholders” of S corporations and highly compensated employees are limited in their ability to exclude all or part of many of the fringe benefits. Partners aren’t employees, so they often do not benefit from the exclusions.

Publication 15-B is comprehensive and references many other IRS publications for further guidance. It is a good read for employers. It is also a good read for employees who want to convince their employers to help them turn some of their taxable compensation into tax-free compensation.

VKM