Offering fringe benefits such as retirement planning services or company lodging can be an excellent way to attract and retain potential new talent. However, employers must keep in mind that these benefits are considered part of the employee’s total compensation before bonuses, and in short, they are subject to taxation. In these situations, employers must follow the imputed income tax rules.
But what is imputed income? What do employers need to know before diving into W-2s and benefit coverage? Here’s what brands need to know about this complicated cashflow to stay on the right track.
What Is Imputed Income?
Imputed income is the cash value of any non-cash fringe benefit employees receive. It’s added to the employee’s gross income and reported on Form W-2 Wage and Tax Statement. Federal income tax and FICA (Federal Insurance Contribution Act) taxes are often withheld from imputed pay. Select case-by-case exclusions may apply. Each situation is different, and employers should approach instances of imputed income as such.
Examples of imputed income vary. This can include group-term life insurance or employee lodging. It also covers the perks that come with some positions. Think of things like use of a company car, wellness programs, gym memberships on the company’s dime, therapy or mental health services, adoption or family services, and more. However, it doesn’t factor in things like breakroom snacks or small gifts.
Fringe Benefits as Imputed Income
Not all fringe benefits count as imputed income. Benefits with lower cash values and infrequent benefits often fall under this category and won’t need to be taxed as part of the employee’s income.
However, some fringe benefits are considered imputed income regardless of their cost. This usually applies to fringe benefits with a recurring monthly value, like gym memberships and use of a company car.
Employers must assign a cash value based on the fair market value for every non-cash benefit that qualifies as imputed income. Alternatively, they may use prescribed IRS tables. This ensures that the amount reflects what the employee would have paid if they were paying for the benefit themselves.
For example, an employer wants to provide group-term life insurance. In this case, the IRS Premium Table, Publication 15-B, determines the cost of coverage over $50,000. Ideally, the employee’s income includes this figure. Similarly, the imputed value for corporate lodging, like employee apartments, is generally the market rental rate for the personal-use portion of the employer’s lease payments.
These values must then be added to the employee’s income and reported for tax purposes. Following these rules will ensure consistency and alignment with the IRS’s often incredibly stringent regulations. These guidelines will also help reduce the stress on employers, especially regarding tax preparedness.
Withholding and Reporting Requirements
Upon determining the value of a fringe tax benefit, employers must withhold federal income tax and FICA taxes (Social Security and Medicare) on the imputed amount. Income tax withholding occurs in one of two ways. The first is by aggregating imputed income with regular wages for the payroll period. The second is applying the flat 22% supplemental wage rate on the benefit value.
Employers are also responsible for reporting imputed income on Form W-2 in the appropriate box. In doing that, they’ll need to include a code that denotes what benefit is provided.
If the total imputed income for group-term life insurance pushes an employee’s wages over $200,000, to return to the earlier example, the excess becomes subject to the Additional Medicare Tax. The employer absolutely must withhold the prescribed amount, subject to the rules about the Add. If not withheld, it needs to be otherwise reported on Form 941.
Exclusions, Exceptions, and ‘De Minimis’ Benefits
As mentioned above, not all fringe benefits count as imputed income. The tax code provides several statutory exclusions.
One example is Section 119, which deals with meals and lodging furnished for the employer’s convenience, including on the employer’s premises. These amounts don’t have to be reported as part of an employee’s gross income. Dependent care assistance up to $5,000 under a Section 129 plan, and that initial $50,000 of group-term life insurance coverage, can also be excluded from employees’ taxable wages.
Small gifts, office snacks, and the like purchased to keep employees happy are likewise exempt when the value is so minimal that accounting for it would be unreasonable. These are referred to as ‘De Minimis’ benefits. So, not every fringe expense must be noted in the accounting ledger to avoid a messy audit.
Compliance and Penalties for Underreporting
As with anything regarding taxes and income, expect steep penalties for noncompliance with regulations about imputed income. Employers who fail to include imputed income on employees’ W-2 forms risk IRS notices for unreported wages, underpayment of employment taxes, and associated penalties and interest.
The IRS cross-checks W-2 and third-party information returns (e.g., 1099s), making accurate reporting essential to avoiding costly audits. Employers should establish internal controls and regular reconciliations between benefit records and payroll data to ensure that all taxable fringe benefits are captured and reported on time.
Should Employers Avoid Imputed Income?
Avoiding imputed income is relatively easy. The simplest solution is not to provide any fringe benefits. If the tax burden of providing perks like company cars, gym memberships, tuition assistance, and additional health benefits to employees outweighs the benefits, then don’t offer fringe benefits.
That said, fringe benefits are a great way to attract top talent and maintain an engaged workforce. Especially in highly competitive industries, offering perks like gym memberships, commuting assistance for non-remote workers, wellness programs, and employee education assistance programs might be expected by top candidates. Even in less competitive industries, perks like this are a great way to differentiate a decent job offer from a great one.
One of the top issues cited by 47% of HR professionals worldwide is employee turnover. Improving employee satisfaction through fringe benefits is one way to keep employees long-term and reduce turnover rates.
So, it’s best to weigh the pros and cons of offering fringe benefits that count as imputed income before completely forgoing them. Businesses might find that the hassles of complying with imputed income tax codes are worth it for happy employees and the ability to attract excellent candidates.
Best Practices for Employers
Employers must maintain clear documentation of valuation methods, withholding elections, and applicable exclusions to manage imputed income effectively. Regular review of IRS updates, particularly Publication 15-B (linked above), will ensure compliance with evolving guidance on fringe benefits.
Training payroll and HR staff on the nuances of taxable versus excludable benefits and periodic audits of benefit offerings can help prevent inadvertent errors and uphold accurate, timely reporting to both employees and the IRS.
By following these guidelines, employers can confidently administer fringe-benefit programs, remain compliant with imputed income rules, and support their talent-attraction and retention strategies without exposing themselves to unnecessary tax liabilities.
Frequently Asked Questions
How do employees remove imputed income?
Unfortunately, there’s no solution for employees looking to remove imputed income tax from their paychecks other than refusing fringe benefits altogether. If employees don’t accept the fringe benefits offered, they won’t have to deal with imputed income, but they won’t receive those benefits either.
How do employers calculate imputed income for life insurance coverage?
Typically, the method is to subtract $50,000 from the total amount of insurance coverage, divide by 1000, and then multiply the total by the Table 1 amount. This is based on the employee’s age.
