Normally, your company isn't required to withhold taxes on non-taxable fringe benefits. After all, the employees generally won't have to pay income tax or FICA on those benefits anyway. But taxable non-cash fringe benefits are a different story. They generally must be reported to the IRS and are subject to withholding of income and payroll taxes.
Nevertheless, the tax law provides employers with some flexibility in this area. Here are the basic rules:
- The company can withhold taxes on non-cash fringe benefits on its regular pay period or some other regular interval (for example, quarterly, semi-annually or annually). What's more, a single benefit can be treated as if it were paid over the course of the calendar year, even if it is actually received all at once. For example, if your employee receives a fringe benefit valued at $1,000 in one pay period, you can treat it as made in four payments of $250, each in a different pay period in the same calendar year. You do not have to notify the IRS of the use of the pay periods.
- Different pay dates may be used for different types of benefits. You do not have to choose the same period for all employees.
- Employers have a choice of withholding methods. For example, the value of the benefits for a payroll period can be added to wages. In this case, you can use the regular withholding tables. Alternatively, the benefit may be treated as a supplemental wage benefit with a flat withholding rate of 25%.
- You must generally determine the value of taxable noncash fringe benefits no later than January 31 of the next year. Before January 31, you can reasonably estimate the value of the fringe benefits for purposes of withholding and depositing on time.
Types of Fringe Benefits
Taxable benefits are included in gross income, unless an Internal Revenue Code (IRC) section specifically exempts them. Fringe benefits can include property, services, cash, and cash equivalents. Example: Bonuses are always taxable because no IRC section excludes them.
Nontaxable benefits do not have to be included in wages if a specific IRC section exempts them. Example: Medical care premiums paid by an employer are not taxable to employees because IRC section 106 excludes them.
Partially taxable benefits exclude a portion of the value from taxation as defined in the tax code. Example: A public transportation subsidy or parking benefit are not taxable up to certain dollar limits.
Deferred taxation benefits include an employer's contributions to an employee's pension plan. These may not be taxable when made, but distributions may be taxed when taken by the employee during retirement.
Special Accounting Rule
Generally, all benefits provided during the year are considered to have been paid no later than December 31. However, the tax law permits you to use a special cutoff date of October 31 for withholding purposes. In other words, you can treat benefits actually provided by employers in November and December as if they were received in the following year.
Note: This does not mean that all benefits treated as paid during the last two months of a calendar year can be deferred until the next year. Only the value of benefits actually provided during the last two months of the calendar year can be treated as paid in the next calendar year. Furthermore, this special rule cannot be used for fringe benefits involving the transfer of real estate or investment property or the value reported for group-term life insurance.
This special withholding rule can be elected for certain non-cash benefits and not for others. In any event, employees must be properly notified if the election is made.
Over- and Under- Estimating
What if you underestimate the value of the fringe benefits and deposit less than the amount you should have? You could be subject to a penalty.
On the other hand, if you overestimate the value of the fringe benefit and deposit too much, you can either claim a refund or have the overpayment applied to your next Form 941.
Finally, be sure that withholding methods are coordinated with the Form W-2s issued to employees for the tax year. The taxation of fringe benefits can be complex. You can rely on a payroll professional to handle the nitty-gritty details.