If the item is not taxable, then it should be excluded from recipients’ gross wages and should not be factored into their Form W-2 wages. Examples of nontaxable fringe benefits include health benefits, up to $5,000 in dependent care assistance and up to $50,000 in group-term life insurance.
Conversely, if a fringe benefit is taxable, then its value is regarded as imputed income and must be counted in the employee’s Form W-2 wages.
As stated by the University of Colorado, “Imputed income is the term for the taxable amount an employee will be assessed for some employer-paid benefits.” Further, it applies to any benefit or service that the IRS considers to be a fringe benefit of employment.
Examples of imputed income
- Group-term life insurance exceeding $50,000.
- Group health coverage for nondependents and domestic partners.
- Adoption assistance over the tax-free amount.
- Educational assistance over $5,250.
- Employee discounts over the tax-free amount.
- Membership in certain athletic facilities, such as an off-site gym.
- Nondeductible moving expense reimbursements.
- Dependent care assistance exceeding the tax-free amount.
- Personal use of an employer-provided vehicle.
- “Gross up” disability plans, in which the employer-paid premiums are taxable to the employee, but actual disability payments are not.
Determining the value of imputed income
You’ll need to know the value of the imputed income in order to withhold applicable taxes and report the income itself. Fringe benefits are, however, often difficult to quantify in dollars. Per IRS guidance, employers “must use the general valuation rule to determine the value of most fringe benefits. Under this rule, the value of a fringe benefit is its fair market value.”
The IRS defines fair market value as “the amount an employee would have to pay a third party in an arm’s-length transaction to buy or lease the benefit.” The fair market value is based on all the facts and circumstances, rather than what the employee thinks it should be or what the employer incurs in order to provide the benefit.
Imputed income: tax withholding and W-2 reporting
You must add the imputed income to the employee’s gross taxable wages, and then withhold Social Security and Medicare taxes plus any other mandated taxes.
As for federal income tax, you can offer to withhold it, but this is optional. The employee can elect to have you withhold federal income tax or pay it when they file their federal tax return. Regarding state tax withholding, be sure to follow applicable state tax laws for imputed income.
Report imputed income on the employee’s Form W-2, including in Box 1 (total gross taxable wages), Box 3 (Social Security wages) and Box 5 (Medicare wages).
For more information on taxable fringe benefits, see IRS Publication 15-B, Employer’s Tax Guide to Fringe Benefits. And give us a call with any questions.