Employers provide their employees with extra benefits other than the basic compensation to attract and retain the top talent in their organization. These extra benefits are called fringe benefits which are also subjected to tax, and the employer may be able to deduct the cost of providing them on their tax return.
However, there are limitations to the amount that can be deducted for each type of fringe benefit. The internal revenue system (IRS) limits the number of tax deductions that employers can claim for providing these fringe benefits. Tax compliance is an essential component of running a long-term successful business for employers.
In this blog, we will discuss the limitations of tax deductions for fringe benefits:
1. Section 162(m) Limitations: In the Internal Revenue Code under Section 162(m), it is stated that the amount of compensation that can be deducted by an employer for some highly compensated employees is $1 million, which includes the CEO and CFO. This limit includes compensation and certain fringe benefits, such as stock options and bonuses. This applies to all publicly held corporations.
2. Section 274 Limitations: Income tax regulations often only permit employers to deduct 50% of the cost of certain entertainment and dining costs under Section 274 of the Income Tax Code. This covers costs expended for meals on the job, entertainment, and concert or sporting event tickets.
3. Section 132 Limitations: Some fringe benefits are excluded from an employee’s taxable income under Section 132 of the Internal Revenue Code, but the employer may only be permitted to deduct a set amount for these benefits. These benefits include:
- Transportation benefits: Employers can deduct the cost of providing transportation benefits to their employees, such as parking or transit passes, up to certain limits. For 2021, the limit on monthly parking expenses is $270 per employee, while the limit on monthly transit passes is also $270 per employee.
- Educational assistance: Companies are only permitted to withhold a maximum of $5,250 per employee annually for educational assistance programs. It can include tuition, books, supplies, and other related expenses for educational or training purposes.
- Dependent care assistance: This is a fringe benefit provided to employees to cover dependent care expenses that include child care or eldercare expenses. Employers are allowed to deduct up to $5,000 per year for qualified dependent care assistance programs.
- Health insurance: The expense of supplying employees with health insurance is often deductible by employers. However, the deduction is subject to a limit based on the average premium for the small group market in the employer’s geographic location. If the cost of the employer’s health insurance plan exceeds this limit, the excess cannot be deducted. For 2021, the limit is $15,800 for family coverage and $7,900 for individual coverage.
4. Section 280G limitations: Under Section 280G of the Internal Revenue Code, if a company goes through a change in ownership, there may be limitations on the number of deductions that can be taken for certain payments to key employees, such as severance payments or stock options. This ownership change can be due to merging, acquisition, or any other transaction resulting in the change of ownership.
Final words
Offering fringe benefits is a great way to attract and retain top-performing staff. However, it is equally crucial to understand tax compliance for the fringe benefits for employers to avoid tax penalties. Check out Compliance Prime’s website to stay updated and learn more about the taxation of fringe benefits in 2023.
