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University of Massachusetts Amherst

Family Business Center

Which Fringe Benefits Are Actually Deductible?

by Shel Horowitz

Everybody's looking for it: the item you can deduct at full value, but costs little or nothing. Unfortunately, those wonderful items are pretty hard to find.

Frequent presenter Kris Houghton, of FBC sponsor Myers Brothers Kalicka, began by offering the audience a lighthearted choice: "I can baffle you with brilliance or bury you with bullshit."

But then she got serious -- and her message has major implications for many businesses. "You and your employees are taxable on all your benefits, on trade in kind and if you get anything that’s non-cash." Of course, you can deduct the full value of the gift, but your employees do have to pay tax on it.

Houghton described a real-life situation while she was auditing a client's books. "I was looking through the trial balance, and I said what’s this $30,000 in L.L. Bean gift certificates?"

The answer: "'We give them to our employees in $100 increments.' I said, you know you have to include those in your W-2. Unless the benefit is so small that it’s 'de minimus' [a legal term meaning too small to be of concern] and we don't account for it -- $25 or less. The next year, I went back, and there were $33,000 in gift certificates. They still weren’t on the W-2 but they bought them in $10 increments." Needless to say, Houghton put the brakes on that little practice.

"Employers want benefits that they can deduct but don‘t have to be counted in income, but the IRS has set very careful limits. Stock options need to be included; any time you get a deduction, it’s going into their W-2. If you make them a promise that you’ll give them something and you don’t provide it, then you can’t deduct it.

All is not lost, however. There are legitimate exclusions, most of them in the category of "working condition fringe": stuff that's necessary to do the job. "You can provide yourself with the nicest office, a secretary, a company car. You need to see what you can give them that might be considered a working condition fringe. It could be a laptop they have a need for, dues and publications; there’s some room for creativity." And these items don't have to be applied equally across the board, as long as they're designed to aid in job performance."

Company cars, however, are a special case, and you should check with your accountant. "To the extent that they drive it for personal use," it needs to be counted as income.

Another category is “no additional cost benefits,” such as employee discounts. Employees can use your goods and services at cost, but not for free. Houghton wasn't sure how to categorize clothing that serves a marketing purpose, e.g., branded shirts that you could wear outside -- but uniforms are okay, as long as it's non-discriminatory.

Athletic and dining facilities are also exempt, if offered to all employees. "You can locate it in the admin building, so that it’s inconvenient for the line workers -- but you can’t discriminate."

Pensions can't discriminate, for the most part. But health insurance rules have a less strict test; you can discriminate, but not on the basis of who owns stock. "You can provide it as a 100% paid benefit for managers and a contributory benefit for the rank and file. The IRS would allow that; I don’t know about the insurance company. This is only for real insurance, not self-insured."

And cafeteria plans can help. "If any one in this room does not have a pretax medical savings account, it’s something you should look into. If you establish a pretax plan and allow all of your employees to make an election, they can submit the bills and get the reimbursement tax free."

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