Fringe Benefits - A Fresh Look to Start the New Year
It's a new year, so it's time to reevaluate everything your organization provides to its employees. Each year my firm assists churches and other organizations in making payroll corrections to properly report the value of various benefits offered throughout the year. To avoid making costly mistakes, it's time for a quick Fringe Benefit 101 update.
Fringe benefits are generally those items provided to employees outside of the normal paycheck. Fringe benefits take on different shapes and different forms and can result in different tax treatments. Many of them are paid directly by an organization, so they never come close to the organization's payroll system. However, some are paid by employees through payroll tax deduction. The IRS has expressed frustration with the omission of items of additional compensation involving benefits provided outside of the traditional paycheck system from being included in employees' income.
In reviewing fringe benefits, it is important to understand the basic premise of our tax system. Under our taxing system:
- All items improving an employee are taxable to the employee until a tax provision can be identified to make it nontaxable;
- Most tax provisions affording tax free treatment of a benefit have rules that have to be followed; and
- Not all benefits are treated the same for all applicable taxes. For example, an employee's elective deferral into a retirement plan is excluded from federal income tax, but it is taxable for purposes of Social Security and Medicare taxes.
Since 2016 has just begun, it is a good time for a benefit review. The review should include the following:
Step 1: Take an inventory of any and all benefits provided to anyone in the organization even if the benefit is only provided to one staff member. Look for those expenses that are paid directly for a staff member or allow a staff member to take advantage of one of the organization's services without charge or at a reduced charge.
Step 2: Review the organizational minutes, budget, employment contracts, etc to confirm that any and all benefits have been properly authorized as additional compensation to the applicable staff member. This step is crucial to avoid the creation of automatic excess benefit transactions under IRC Section 4958. It is also necessary to confirm that a staff member's compensation is still within the realm of reasonable compensation.
Step 3: Review the rules regarding the benefit to determine if the rules are being met. Virtually every benefit that can be provided by an organization has a required framework to achieve tax favored treatment. For example, the majority of benefits are required to be offered on a nondiscriminatory basis and cannot be offered just to those in upper management. For churches, this requires a good review of any benefit exclusively offered to the ministerial staff members.
Step 4: Determine the steps that need to be taken to bring the benefit into alignment with the rules. If there is a plan already in place that appears to comply with the rules, have this plan reviewed every few years to determine if it is still in alignment with the rules. This may require the assistance of either a CPA and/or an attorney. When selecting these professionals always select those who are experienced in working with nonprofit organizations. Churches should select professionals with specific experience working with churches, since some benefits afford special considerations for churches.
Step 5: Review the reporting requirements for the benefit and determine the applicable taxes that may or may not be due. As previously mentioned, some benefits require special reporting and some are exempt from federal income tax but still subject to Social Security & Medicare taxes.
Step 6: Document the results and make corrections in the payroll system to achieve the appropriate tax treatment. It's only January, so make any payroll corrections now to avoid having to amend quarterly Forms 941 in the future. Additionally, if a benefit is going to create taxable income to an employee, it is better to make that determination at the beginning of the year, rather than the end of the year.
The IRS provides Publication 15-B, An Employer's Tax Guide to Fringe Benefits, as a useful guide in evaluating benefits and related tax requirements and can be obtained at www.irs.gov. Don't let your organization's benefit plans become an unexpected tax burden to either the organization or its employees, Be proactive in protecting and benefiting both the organization and the employees with your 2016 benefit review.