When it comes to hiring and retaining talented employees, fringe benefits can help small businesses owners compete with larger rivals that often have more resources and more clout. And in many cases, you can do it without adding to your own or your employees’ tax burden.
“Increasing pay [for your best employees] may not be the best strategy,” writes tax expert Barbara Weltman in a 2013 blog post that argues in favor of fringe benefits. “Added pay is taxable to employees, so they net less. Plus added pay has additional costs to you in the form of payroll taxes. What to do? Think about giving them fringe benefits.”
From adoption assistance to life insurance to commuter benefits, the Internal Revenue Service (IRS) specifies more than a dozen different categories of tax-advantaged fringe benefits. Here’s a closer look at what’s required, what’s optional and what’s available when it comes to designing a benefits plan that will help your small business compete.
Employee Benefits: What’s on the Fringe and What Isn’t
You’ll need a good benefits plan to compete for talent, especially if your small business operates in a tough market. And yet, by law, you don’t have to provide much to employees.
Federally-mandated benefits are generally limited to social security, unemployment insurance, worker’s compensation and some leave—although not all leave has to be paid. For example, government agencies and companies employing 50 or more staff are required to grant leave under the Family and Medical Leave Act (FMLA). FMLA allows workers to take up to 12 weeks of unpaid leave to care for a new baby or an ailing family member, or for a personal illness.
Health care benefits and retirement plans, on the other hand, are entirely optional. Paid vacation, too, is on the fringe, next to tuition reimbursement and gym memberships. But would leaving these benefits out to save the cash be worth it? Not if you’re trying to find and hire qualified candidates. Mickey Swortzel, co-founder and Chief Financial Officer of New Eagle, an Ann Arbor, Michigan, supplier of control systems for vehicles, has invested heavily in fringe benefits in hopes of attracting top talent to his 20-person shop.
“We are in the heart of the automotive industry and to attract and retain top talent, we need to offer Fortune 500-level benefits,” says Swortzel. In addition to a company 401(k) plan, health insurance, and disability, life and long-term care coverage, the machining shop also offers its employees access to supplemental insurance, discounts on cell phone plans, movie tickets and health club memberships.
“We are part of a larger buying group that provides these additional benefits and find that professionals appreciate these benefits when comparing companies. Benefits help us to be viewed [by potential employees] as a viable, competitive organization,” Swortzel explains.
The “buying group” he refers to is what’s known as a Professional Employment Organization, or PEO, in which small business owners hand over all benefits administration to a professional provider—from payroll to insurance and more—in exchange for a fee. ADP handles New Eagle’s benefits as part of its Total Source PEO.
Fringe Benefits: What the Tax Man Says
Your small business may be growing fast enough to handle offering not only insurance and retirement benefits but also one-off perks that feel more like fringe benefits. At Red Caffeine Marketing + Technology, a 24-person agency located in the Chicago suburb of Lombard, Illinois., that includes picking up the tab for happy hour drinks every Thursday, work-from-home arrangements and monthly massages. The goal is to get everyone fully engaged in the business, says Red Caffeine PR director, Bernice Mirrilees.
“Leadership is purposeful about listening to what employees want and value,” Mirrilees says. “They’ve also asked us for input on our significant community giving. We give a sizable portion of our revenue in cash gifts to non-profits and pro-bono work, as well as supporting one another on causes that are important to each of us.”
And its likely that these extra perks aren’t costing Red Caffeine or its employees anything in additional taxes. When it comes to offering fringe benefits to employees, the IRS gives small business owners plenty of latitude. Here’s a quick summary of the options:
- Health and accidental death benefits. Contributions made to health plans on behalf of employees are generally exempt from federal unemployment tax and most income tax, but there are exceptions. Long-term care coverage offered through a flexible spending account usually isn’t exempt. Also, if you’re an owner, you may be required to pay Social Security and Medicare tax.
- Achievement awards. Call this the gold watch benefit. Employees generally don’t have to pay tax on awards granted for length of service or safety achievements, so long as the items don’t exceed $1,600 in value in a given year.
- Adoption assistance. Reimbursed expenses paid to employees for adopting a child are exempt from federal income tax, but not social security, Medicare and unemployment tax.
- Athletic facilities. Companies that build on-site athletic facilities for use by employees, their spouses and their dependent children can offer access as a tax-exempt benefit. Note: This does not include gym memberships.
- De Minimis benefits. These benefits are officially defined as property or a service that has “so little value” that accounting for it would be unreasonable. As a result, they’re tax-exempt. These tend to include theater tickets and occasional company parties.
- Dependent care assistance. Most employees will qualify for up to $5,000 in tax-exempt assistance for day care. (This drops to $2,500 each for married couples filing separately.) See page 9 of IRS Publication 15-B for the details on what it takes to qualify for this benefit.
- Educational assistance. This doesn’t just include tuition assistance, but also payments for books, equipment and other expenses related to continuing education. Eligible employees can receive up to $5,520 in annual tax-exempt assistance.
- Employee discounts. Give your employees a discount toward your goods and services—within limits. Consult a tax advisor before you set the percentage.
- Life insurance coverage. This is tax-exempt up to the first $50,000 in benefits offered to insured employees.
- Health Savings Accounts (HSA). While there are limits, qualifying employees covered by a high-deductible health plan can contribute, tax-free, up to $3,350 for just themselves or $6,750 for a family to cover out-of-pocket health expenses.
- Lodging (on your business premises). This benefit is exactly as it sounds, believe it or not. Say you run a factory. As a condition of employment, you can offer workers housing on site at your facility, free of charge, and they won’t be taxed for the benefit.
- Meals. Whether it’s the occasional round of donuts and coffee, setting up an on-site cafeteria for staff, or even buying lunch from the restaurant next door, feeding your team can be a welcome tax-free add on.
- Moving expenses. Payments made to help employees move are tax-exempt so long as they’re for services employees would have had to pay on their own.
- No-additional-cost services. Think of these as capacity benefits, such as an airline offering its employees the right to fly free on trips where there are unsold seats. Most small businesses won’t have this luxury to offer, unfortunately, but there are exceptions. For example, a local bookstore may let employees pick from the list of surplus copies before they head to the $1 bargain bin.
- Retirement planning services. You can pay to give your employees tax-free access to a retirement specialist, but not an accountant or tax advisor.
- Transportation benefits. Up to $255 monthly for transit passes and other shared commuting services is tax-free. Or, for employees who drive, up to $255 monthly for parking. You can also reward employees with $20 tax-free for every month they use a bicycle as their sole vehicle for commuting to work if they? don’t receive other commuting reimbursements.
- Working condition benefits. Employees are allowed tax-free access to equipment to perform their jobs. This may include providing a company car for business or paying monthly reimbursements for the cost of a mobile phone used for business. Both are typical working condition benefits.
Stock options are also singled out as fringe benefit by the IRS in Publication 15-B, but the rules governing their use are murky enough that it would be disingenuous to deem them a tax-advantaged benefit. For some employees, they may not be.
What Can You Offer?
If you want to offer fringe benefits, tax-free, keep in mind that every employee must have access. Some benefits—like offering health insurance, for example—are only tax-advantaged when offered on a “non-discriminatory” basis. What if you want to reward a single employee with a fringe benefit?
That’s possible, though your employee will be taxed on the reward as if it were income. The key is to make the reward attractive enough that it beats a cash bonus. One potential example: offering an in-need worker the option of keeping a company car for personal use.
“Say the taxable value of offering the benefit works out to be $2,000 for the year. If the employee is in the 25 percent tax bracket, it means a tax cost of $500. In other words, for a mere $500, the employee enjoys the use of the company car for commuting … much less than it would cost to use a personal vehicle or even public transportation,” Weltman writes.
Consult a tax advisor before making assumptions about the benefits you provide to employees. But don’t limit yourself—get creative. Fringe benefits may seem like one-offs, but used correctly, they can also provide a tax-smart way to help staff. Do that often enough, and you won’t have a problem recruiting and keeping top talent—even in tough markets.