Table of Contents
- Overview of Tax Savings on Employee Benefits
- What Is FICA Tax?
- Taxable Fringe Benefits
- Simplify Your Benefits Administration With Paychex
Recruitment and employee retention top the list of challenges for most human resources professionals. HR teams everywhere qualified candidates who are a culture fit and committed to staying with the organization.
Given these types of challenges, how can you attract and retain qualified talent? Companies competing for talent must offer not only competitive pay but also attractive employee benefits packages, designed to meet the needs of multiple generations within the workplace. As a plus to you, many benefits are tax deductible, helping you reduce taxes owed at the end of the year. However, many fringe benefits, which are often overlooked, are non-taxable.
Overview of Tax Savings on Employee Benefits
Just like wages (e.g., salary, commissions, and bonuses), the cost of employee benefits is tax-deductible. Deducting these employee benefits can play a critical role in your financial planning and tax strategy.
Additionally, your employee benefits may be exempt from employment taxes. For example, you may not have to pay certain employment taxes, such as your Federal Insurance Contribution Act (FICA) tax (your Social Security and Medicare taxes), on the amount of non-taxable fringe benefits. More specifically, you pay 6.2 percent for Social Security taxes on compensation up to the annual wage base ($168,600 in 2024). You also pay 1.45 percent in Medicare taxes on all compensation. But some employee benefits are treated as tax-free compensation, making them exempt from Social Security and Medicare (FICA) taxes.
What Is FICA Tax?
Federal Insurance Contribution Act (FICA) tax is a federal payroll tax paid by both employees and employers, consisting of a Social Security tax and Medicare tax. The FICA tax rate is applied to all taxable compensation, including salary, tips, bonuses, commissions, and taxable fringe benefits.
Which Benefits Are Exempt From FICA and Federal Income Tax?
Employers know that attracting and retaining talent in today’s job market is challenging. By offering non-taxable fringe benefits, you can differentiate yourself in the marketplace by enhancing your employees’ overall compensation package while tailoring benefits to your teams’ needs and wishes.
Two of the most popular tax-exempt employee benefits — health insurance and employer contributions to qualified retirement plans — are not subject to FICA or federal income tax.
However, these aren’t the only benefits that can be offered free from the FICA tax. The Internal Revenue Service (IRS) has also highlighted additional tax-deductible employee benefits, including:
- Achievement awards: Awards you give to employees for length of service are exempt from FICA up to a set dollar limit ($1,600 for qualified plan awards; $400 for nonqualified awards).
- Cell phones: This cost is exempt if the primary reason for providing them to employees is for business, not just as compensation.
- De minimis fringe benefits: Coffee in the break room, an occasional taxi ride home at night, and flowers for a personal occasion are examples of de minimis benefits that are exempt, but cash (including gift cards) in any amount is taxable.
- Dependent care assistance: Employer-paid assistance is exempt up to $5,000 annually.
- Educational assistance: Educational tuition assistance is exempt up to $5,250 annually, as long as these benefits are provided because of the employer-employee relationship.
- Group-term life insurance: The cost of coverage up to $50,000 is exempt. Coverage for a spouse or dependent is exempt only up to $2,000.
- Health savings accounts (HSAs): Employer contributions to employees’ accounts are exempt up to the dollar limit per year. (In 2024, it’s $4,150 for self-only coverage and $8,300 for family coverage under a high-deductible health plan to a qualified individual’s HSA (Health Savings Account). For 2025, those limits are increased to $4,300 for self-only coverage and $8,550 for family coverage).
- Meals and lodging: The value of providing these taxable benefits on company premises for the convenience of the employer is exempt.
- Transportation benefits: The costs for parking, transit passes, and van pooling are tax-free up to a set monthly limit ($315 in 2024).
Which Benefits Are Not Exempt From FICA?
While many employee benefits are exempt from FICA tax, some are not. For example, adoption assistance is tax-free to employees up to a set dollar amount each year per adoption ($16,810 in 2024). However, this benefit is still subject to FICA.
Additionally, for tax years beginning after 2017 and before 2026, moving reimbursements are no longer tax-deductible, per the Tax Cuts and Jobs Act.
What Do S Corporation Owner-Employees Need To Know About Employee Benefits?
While S corporation shareholders can be designated as employees, they often cannot enjoy the same benefits as non-shareholders. Here are some exceptions that apply to S-Corp shareholders owning more than 2 percent of stock:
- Achievement awards are not tax-free to shareholder-employees and are not exempt from FICA.
- Group-term life insurance is not tax-free to owner-employees. Because shareholder-employees are treated as partners in a partnership for purposes of this fringe benefit, the benefit is treated as taxable compensation subject to FICA.
- Health insurance must be included in a shareholder-employee’s compensation. They can deduct the premiums as an adjustment to gross income on Form 1040. However, the coverage is exempt from FICA.
- Health savings account contributions are treated as taxable income, not tax-free contributions.
- Meals and lodging for an owner-employee on company premises are not tax-free benefits.
- Moving reimbursements are not tax-free benefits exempt from FICA.
- Transit passes treated as tax-free are capped at $21 per month. If the cost exceeds $21, then the total amount is taxable.
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Taxable Fringe Benefits
In such a fierce talent market, employers shouldn’t discard the idea of offering taxable fringe benefits to their employees. Any type of fringe benefit can enhance your employees’ experience, even if some tax is owed.
So, what is the difference between taxable and non-taxable income?
Any amount included in an employee’s income is taxable unless specifically exempted under law. Taxable income must be reported on the employee’s Form W-2, Wage and Tax Statement. These benefits are typically subject to Federal income taxes and FICA. For example, bonuses are taxable because no section of the Internal Revenue Code excludes them from taxation.
But what are untaxed income benefits? Untaxed income benefits, or non-taxable fringe benefits, may be reported, but they are not taxed. For example, qualified health plan benefits are non-taxable since they are expressly excluded under the Internal Revenue Code.
Why Should I Offer Taxable Fringe Benefits?
Offering taxable, low-cost fringe benefits to an employee still provides considerable value. The cost to the employee for receiving a taxable benefit is considerably less than what it would cost the employee to pay out-of-pocket for it. Additionally, you can offer a wide range of taxable fringe benefits, boosting your recruitment and retention strategies.
Which Taxable Fringe Benefits Should a Business Offer?
Despite the income tax cost to employees (and the added payroll tax cost to employers), certain fringe benefits are taxable, so your offering is limited only by your imagination and your budget.
Here are some of the employee tax deductions you might want to consider:
- Cash awards and most non-cash awards
- Excessive mileage reimbursements
- Bicycle commuting reimbursements
- Excess educational reimbursements
- Any reimbursements without adequate proof or accounting
- Personal use of a company vehicle
How Do Taxable Fringe Benefits Impact My Payroll Costs?
Because taxable fringe benefits are taxable compensation to employees (other than where noted), they are subject to both federal income and payroll taxes. For example, there’s a 7.65 percent FICA cost to employers on these benefits. Be sure to factor in state-level payroll costs, such as unemployment tax and workers’ compensation, as they often vary from state to state.
If the taxable fringe benefits are merely cash payments, then include these payments with the employee’s regular compensation and withhold accordingly. If the taxable fringe benefits are not in cash (e.g., personal use of a company vehicle), then special rules come into play that provide you with considerable flexibility in handling payroll taxes.
You can treat taxable non-cash fringe benefits as paid on a pay period, quarter, semiannual, annual, or other basis if they’re treated as paid no less frequently than annually. You don’t have to choose the same period for all employees; you can withhold more frequently for some employees than for others. You can also change the period as often as you want or need to, if you treat all the benefits provided in a calendar year as paid no later than December 31st.
You can even treat the value of a single fringe benefit as paid on one or more dates in the same calendar year, even if the employee receives the entire benefit at one time. For example, your employee receives a fringe benefit valued at $1,000 in one pay period during 2024. You can treat it as made in four payments of $250, each in a different pay period of 2024.
You don’t have to notify the IRS of the use of different pay periods.
Before you start expanding your menu of benefits, consider surveying employees to learn what they really want. It may turn out that benefits such as a long-term, flexible work schedule, which is at no cost to you or your staff, are particularly valuable to them.
What Are Some Commonly Overlooked Tax Deductions?
Even experienced small-business owners can face financial challenges at some point during their company’s lifetime. One way to help offset costs is by uncovering qualifying business tax deductions.
Companies leave billions of tax credit dollars unclaimed each year. To help remedy this, be aware of which fringe benefits qualify for tax deductions. You may not know it now, but there could be money out there waiting for you to claim during tax filing season.
Here are some common tax deductions that are available to qualifying businesses:
- Federal Work Opportunity Tax Credit: Employers who hire qualified employees could qualify for this deduction. It’s typically 40 percent of the first $6,000 paid to each qualifying employee during the first year of employment. Employers who hire qualified veterans could see a credit of up to $9,600.
- Healthcare tax credits: Under the Affordable Care Act, qualifying businesses with fewer than 25 full-time equivalent employees can deduct up to half of their contributions toward employees’ health insurance premiums (up to 35 percent for tax-exempt employers), based on FTE (full time equivalent employees) count or average annual FTE wages, as long as they offer coverage through the Small Business Health Options Program.
- Section 179 expense and bonus depreciation: Your company can deduct the total cost of qualifying equipment (new or used), up to $1,220,000, and a value of property purchased to $3,050,000 from your 2024 taxable income.
- Retirement plan expenses: Tax benefits are available when you establish a retirement plan for you and your employees. First, you could receive deductions for plan contributions that you put on your personal income tax return. Additionally, costs associated with establishing a plan are deductible by up to 50 percent (up to $500 per year) during the first three years of plan implementation. SECURE Act 2.0 expanded these start-up benefits, giving small employers more flexibility when setting up a retirement plan.
- Expenses for starting a business: Current business expenses such as advertising, transportation, facilities, and consultants’ fees can be deducted. Capital expenses to get a business up and running can be deducted up to $5,000 in the first year.
Other common deductions for business owners can include home office expenses, business-related software and subscriptions, business use of a cell phone and car, and legal expenses.
At the state level, many states also offer tax credits for businesses that create jobs, conduct research and development, or make certain investments. A tax professional who is familiar with credits at the state level can help ensure you are identifying all business deductions, further benefiting your organization.
Organizations can use professional tax services to discover additional tax credit opportunities, feel more confident about determining their eligibility for tax deductions, and claim credits that may not have been mentioned above. Maintaining proper records and taking advantage of a tax professional’s services can help you maximize your tax savings while ensuring that you don’t miss any commonly missed tax deductions.
Simplify Your Benefits Administration With Paychex
Offering a comprehensive employee benefits package, including both taxable and non-taxable fringe benefits, is essential when attracting, retaining, and engaging top talent. Paychex can help you stay on top of benefits trends and compliance needs while helping you administer a benefits package tailored to your organization and its employees.
For more information or questions attracting and retaining talent click here, call (844) 846-7824 (promo code 6186) or email mycorp@paychex.com