Employee Compensation: To tax or not to tax?

When it comes to the various types of employee compensation, small business employers may find it difficult to determine what to tax and what not to tax on their employees’ paychecks. While everyone knows that compensation in the form of gross wages, commissions, and tips are taxable, not all forms of compensation are so straightforward. Fringe benefits, for example, can get tricky, and to add to the confusion in that area: some benefits are exempt from income tax withholding but subject to FICA and FUTA, or vice versa. So, what are some of these trickier items, and are they taxable, non-taxable, or somewhere in between?

• Use of a company vehicle: If an employer provides an employee with a company vehicle, the business-related use of the car is exempt from tax, as the employee would have been able to claim a deduction had they incurred this expense themselves. However, personal use of the car must be accounted for separately, via mileage tracking, as personal mileage is fully taxable.
• Cell phones: Given the above rule, you may think that the personal use of a company-provided cell phone is taxable, but that is not the case. Personal use in the case of cell phones is considered de minimis and is exempt from tax.
• Adoption assistance: Money paid to an employee to assist with adoption costs is exempt from income tax withholding, but it is subject to FICA and FUTA.
• Group-term life insurance: This benefit is exempt from income tax withholding and FUTA. The first $50,000 is exempt from FICA, while anything over $50,000 is subject to FICA.
• Gift Cards: Gift cards, even in small amounts, are fully taxable to an employee, or not deductible for the company.
• Educational assistance: If paid as part of a qualified educational assistance program, this benefit is tax exempt, but only up to $5,250 per year. Any amount exceeding $5,250 in a calendar year is taxable to the employee.

This is just a small sample of some of the trickier items, so it is best to consult a tax professional when starting a new business and bringing employees aboard.

Caroline Chrisman, Outsourced Accounting Staff Accountant
[email protected]