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Avoiding Tax Problems with New Benefits

Providing a taxable benefit without realizing it can cause problems down the road

A man in a mask holding a basket of food.

With the COVID-19 pandemic forcing major changes around where and how employees do their work, employers are altering their benefits to meet emerging needs and to ensure engagement with a scattered workforce.

Sending employees lunch for regularly scheduled video team meetings and get-togethers and offering free virtual sessions with personal trainers to replace the workplace gym may seem like nice perks right now. However, depending on the value of those extras and their frequency, employers could have established taxable benefits for employees without realizing it. This is particularly true when employers offer benefits on an ad hoc basis.

"Considering how quickly employers needed to get their employees up and running remotely when the work-from-home orders were issued, and then maintain employee morale for months on end, it's not surprising the tax treatment of a particular benefit or perk wasn't at the top of anyone's mind," said Belinda Morgan, a partner with law firm Foley & Lardner LLP in Chicago.

Benefits and Taxes

Now that work-from-home arrangements and other workforce changes have become routine, employers may want to consider whether these new benefits are a normal business expense or a "fringe" benefit, and whether there's a tax liability for employers and employees. (It should be noted that while employer-sponsored benefits are now central to employees' rewards and no longer on the fringe, the phrase "fringe benefits" is still used by the IRS in discussing benefits' tax status.)

Here are some steps for understanding and handling tax issues around benefits.

Know what you offer

It's a good idea to audit existing benefits and any new programs that were launched during the pandemic to make sure they are being handled appropriately from a tax perspective. With a comprehensive list of offerings, employers can then work with tax and legal advisors to determine whether the offerings are taxable or nontaxable.

"Small rewards for good performance, such as an employer-branded hat or a similar inexpensive item, will be nontaxable," Morgan said. "If that reward is payable in the form of a $5 Starbucks gift card, however, it will be taxable," even if the monetary value of those two gifts are the same.

She suggested that employers review IRS Publication 15-B during any self-audit as a guide on how to handle these programs taxwise. Morgan has also written about the potential treatment of specific types of benefits.

Recognize the line

Not everything employers provide to workers is a fringe benefit. However, the lines between business expenses and benefits are not always clear. The pandemic "has been a time of change and uncertainty and misinformation," said Sean Manning, CEO of Payroll Vault, a payroll and HR services firm in Denver. "But it is important to realize that certain things haven't changed." For example, if an organization has been sending employees meals or gift cards regularly, it may have created a taxable benefit for employees. However, "if you are sending employees coffee and doughnuts to make Zoom meetings more fun and engaging, that may now simply be considered a business expense," Manning said.

If employees are working from home, Manning noted, employers can make the case that tools such as upgraded smartphones, home office equipment, and some office furnishings and decoration are business expenses and not fringe benefits.

For example, employers could be giving an allowance to employees who spend a good deal of time on video calls with clients, prospects and business partners. Employees would then use those funds to create an appropriate visual setting for these calls using furnishings and, possibly, a green screen to project a background image during a call.

Employers would still need to document why these purchases qualify as reasonable business expenses. In all cases, employers should consult with tax and legal advisors to determine where various offerings fall on the business expense versus fringe benefit continuum.

[SHRM members-only HR Q&As: Are there any tax issues we need to be aware of when we give employees a gift card or other small gift?]

Address problems

Depending on the circumstances, providing a taxable benefit to employees without recognizing or reporting it as such, particularly over a long period of time, could cause problems for both employers and employees. The value of taxable benefits must be included in each employee's taxable income and is subject to normal employment tax withholding.

"A mistake in determining whether a fringe benefit is taxable will cause the employee's income to be understated, possibly leading to underpaid taxes," Morgan said. This may cause minimal problems for individual employees receiving benefits with a modest monetary value. However, "if the error is multiplied across an entire workforce, it could be a substantial problem for the employer" and include penalties for failing to withhold the employment taxes and report employees' taxable income. The employer could also be liable for income and employment taxes that were not withheld, she said.

The good news is that employers have time to address any errors in the classification of these benefits and expenses before the end of the tax year. Working with their tax and legal advisors, employers can still include taxable benefits in employees' wages and file the paperwork necessary to address underreported taxes.

When addressing unreported noncash benefits, "employers can elect to treat such fringes as paid on a pay period, quarterly, annual or other basis, as long as they treat them as paid at least annually" and not later than Dec. 31, Morgan said. "There's no formal election required, and employers aren't required to notify the IRS about the method they want to use."

For example, if an employer realizes that certain noncash fringe benefits are taxable, these rules allow employers to include the value of the benefit in employees' wages and withhold any employment taxes at any point before the end of the year.

Remain vigilant

Once employers work through any issues related to their benefits' tax liability, it's important to remain vigilant to prevent new problems from occurring. "I suspect once an employer has done the initial audit, it will be more cautious when adding new fringe benefits," Morgan said. 

Given the potential repercussions of making a mistake in the treatment of a benefit, "it's definitely worth an employer's time to get it right the first time," she added.

Joanne Sammer is a New Jersey-based business and financial writer. 

Related SHRM Articles:

Do New Tax Rules Throw Cold Water on Employee Events?, SHRM Online, May 2019

The IRS Says Let Them Eat Snacks, SHRM Online, March 2019

Reminder: Holiday Gifts, Prizes or Parties Can Be Taxable Wages, SHRM Online, November 2016

[Need help with legal questions? Check out the new SHRM LegalNetwork]


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