The holiday season is a natural time for employers to show appreciation, whether it’s through a year-end bonus, a thoughtful gift, or an extra perk. But when it comes to taxes, the IRS doesn’t always see these tokens of gratitude the same way you do. What feels like a simple “thank you” to your team can sometimes be classified as taxable income, leading to unexpected complications for both employees and employers.
To help you stay within the rules and avoid negative consequences, we’ve outlined five of the most commonly overlooked fringe benefits that are considered taxable, and what you can do to handle them the right way.
Gift Cards Are Always Taxable
A box of chocolates? Usually a gift. A $50 Visa card? That’s considered cash equivalent compensation in the IRS’s eyes. Even though many employers hand them out freely, gift cards should always be treated as taxable income. That means grossing them up through payroll and applying the proper withholdings.
The best way to handle this: process gift cards through payroll so employees aren’t caught off guard at tax time and your business stays in the clear.
Personal Use of Company Cars
That company vehicle isn’t just a perk. It’s taxable if employees use it for personal reasons. Driving to client sites is considered business-related, but heading out on a weekend getaway counts as personal use and needs to be recorded as taxable income.
Clear policies and accurate mileage logs make it easier to calculate the taxable portion fairly and keep you aligned with IRS rules.
Employer-Paid Group Term Life Insurance Over $50,000
This is one of the most common mistakes businesses make in meeting their state and federal obligations. The IRS allows the first $50,000 of group term life insurance coverage per employee to be tax-free. But anything beyond that is considered a taxable fringe benefit and must be reported as income.
The mistake many employers make? Waiting until December to report the full year’s worth. That leaves employees with a much smaller final paycheck and creates a time crunch for HR.
A smarter approach: report group term life benefits per pay period, not just at year-end. This smooths out the tax impact, avoids unpleasant surprises, and saves your team from a year-end scramble.
Special Rules for 2% S-Corp Shareholders
If you have S-Corp shareholders who own 2% or more of the company, fringe benefit rules work differently, especially for health and life insurance. Many business owners overlook this distinction, but failing to apply the correct tax treatment can cause legal issues down the road.
To stay on the right side of the law, work with your payroll provider to make sure S-Corp shareholder benefits are tracked and reported correctly.
Holiday Bonuses
Cash is always taxable, even if you call it a “holiday bonus.” But the tax implications go deeper than just withholding. Bonuses can impact:
- Taxation & Withholding: Bonuses should be processed at the supplemental withholding rate, not with taxes “blocked.” Blocking federal and state taxes shifts liability onto employees, leaving them to settle up later with the IRS or state agencies, something that can create stress and frustration.
- Gross vs. Net Bonuses: Many employees expect the bonus amount they hear (“$1,000 bonus!”) to be the net amount they take home. Without clear communication, the difference between gross and net pay can cause confusion and disappointment.
- 401(k) Eligibility: Bonuses may or may not count toward retirement plan contributions. It all depends on the plan design. Some plans include them, some exclude them, and some leave it optional. Employers should not block bonuses from 401(k) withholding unless they’ve confirmed in advance whether bonuses are considered eligible wages. If an employer improperly blocks contributions, employees could face an audit later and be required to fund a large amount retroactively.
- Employee Classification Impact: For hourly (non-exempt) employees, bonuses promised in advance or tied to performance goals must be factored into the “regular rate of pay” for overtime calculations under the Fair Labor Standards Act (FLSA). This means bonuses can affect overtime pay calculations and mishandling them could create wage-and-hour legal issues.
- State Rules: Several states, including Massachusetts, Maine, New Hampshire, and New York, have their own bonus-related requirements that employers must take into account. For example, Maine classifies bonus payments as wages under its regulations, meaning nondiscretionary bonuses promised upfront must be included in regular rate calculations and treated according to its wage laws.
The simplest way forward: plan bonuses in advance, communicate clearly with employees, and coordinate with your payroll team to ensure taxes and retirement contributions are handled correctly.
How CommPayHR Can Help with Taxable Fringe Benefits
Fringe benefits can be a wonderful way to reward and motivate your employees, but they also come with important tax responsibilities. At CommPayHR, we specialize in helping businesses navigate these complex rules, apply the correct tax treatment, and stay ahead of year-end reporting. Our expertise ensures accuracy, reduces costly surprises, and gives you peace of mind knowing your payroll is in good hands. Let CommPayHR lead the way through the complexities of fringe benefit rules, so you can spend more time building the business you’ve worked so hard for. Contact us today!
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