Just when I think government laws, regulations and rules can get any dumber, I come across yet another ridiculous one.
The year isn’t over yet, but it will be before you know it. So on this episode I want to help you prepare for year end from the standpoint of reporting and paying payroll taxes on earnings and compensation that wasn’t processed through your normal payroll process.
There are forms of cash compensation that often don’t get run through the payroll system and taxed on time. Things like…well, cash bonuses, gift cards, expense reimbursements that don’t qualify as non-taxable payments, and tangible or intangible personal property that’s normally held for investment, or a transfer of real property. Ok, not so much the last two, but it happens.
There are also many forms of non-cash fringe benefits and some of those are taxable income and require withholding, payment and reporting before the end of the year.
So all taxable compensation from these categories needs to be processed through the payroll system and taxes need to be withheld, paid and reported. Cash payments should have been included in payroll when they were paid or, in the case of personal and real property, when the transfer took place.
Most small employers either fail to report these earnings or end up reporting them to their payroll service provider or their payroll manager, after the end of the year. At that point, you’ve incurred penalties and interest on the related tax.
It’s a good time to start figuring out what needs to be calculated and processed in the payroll system so the taxes are reported and paid on time and you’re not late sending out the W-2s.
Cash and cash equivalent payments are taxable when paid but non-cash fringe benefits may generally be processed through payroll at the end of the year without any late reporting or payment penalties.
Here is a basic process you should follow at the end of each year to identify (1) what fringe benefits were paid, (2) if they are taxable, (3) how to value them, and (4) how you should be withholding, paying and reporting them. Your guide for this is the IRS Publication 15-B, Employer’s Tax Guide to Fringe Benefits.
(1) Ok, first off, what did you pay in fringe benefits. Look for anything you gave your employees that wasn’t processed through payroll. Things like cash, gift cards, relocation payments, group-term life insurance or personal use of a company vehicle.
Check out the list in the show notes.
(2) Now that you’ve identified them, are they taxable? All fringe benefits are taxable UNLESS they are specifically excluded from income or or have a special tax rule, in whole or in part. To ID these fringe benefits go to Section 2. Any benefit not excluded under section 2 is taxable.
Section 2 doesn’t exclude all amounts – for example, achievement awards. The first $1,600 is excluded from income, if you have a qualified award plan, which is written plan or program that doesn’t favor highly compensated employees when it comes to eligibility or benefits. If you don’t have qualified award plan, then only the first $400 is excluded from income.
So if you give your employee a $1,000 watch as an achievement award and you don’t have a qualified plan then you need to process a $600 taxable earning through your payroll. If you have a qualified award plan then you don’t have to report any of it
As a side note, an award isn’t a qualified plan award if the average cost of all the employee achievement awards you’ve given during the tax year is more than $400. And when you’re coming up with that average you can’t include awards of nominal value to help lower the average.
There are 20 specific fringe benefits that have some variety of special exclusion rules. So if you’ve paid one of them, find the explanation in Section 2 and read it.
(3) Now how do you value the taxable fringes? There are 5 rules and four of them apply to transportation. So you’ll use the first rule, the General Valuation Rule for most fringe benefits. There’s also a special valuation rule used for meals provided at an employer-operated eating facility for employees. Oh, and there’s also a aircraft fringe benefit valuation rule. So I guess that’s 5 generals and 2 specials.
The GVR uses fair market value which is the amount an employee would have to pay a third party in an arm’s-length transaction to buy or lease the benefit. Don’t ask your employee what they consider the value to be… that doesn’t matter and neither does your cost to provide. That’s not what determines fair market value.
For employer-provided vehicles, the FMV is the amount your employee would have paid a third party to lease the same or similar vehicle on the same or comparable terms in the geographic area where they use the vehicle.
The other ways to calculate the value of a company provided vehicle. There’s the cents-per-mile rule, the commuting rule and the lease value rule. And lastly, there is this one that frankly I wasn’t aware of. It’s called the Unsafe Conditions Commuting Rule.
This is transportation you provide due to unsafe conditions. But what the heck does that mean? Well, an unsafe conditions exist if, under the facts and circumstances, a reasonable person would consider it unsafe for the employee to walk or use public transportation at the time of day the employee must commute. One factor indicating whether it is unsafe is the history of crime in the geographic area surrounding the employee’s workplace or home at the time of day the employee commutes.
It only applies where your employee would normally walk or use public transportation to get to work, you have a written policy that says no personal use of the benefit and your employee doesn’t in fact use the benefit for personal use.
So you could pay the Uber bill where these conditions are met, and it only applies to hourly paid employees who are entitled to overtime and who don’t earn more than $120k per year.
(4) And the final step is withholding, reporting and paying. Basically you have until January 31st to calculate the value of non cash fringes for the prior year. If you want to calculate, process and pay the tax on any other more frequent pay period you’re certainly welcome to do that. For example, maybe you want to process the personal use of company vehicle quarterly and process it on the first payroll of the next quarter.
This doesn’t apply to payments of tangible or intangible personal property that’s held for investment or to real property. For this stuff, the date the transfer happened is the pay date.
For tax calculation you can either add the value to regular wages and let they software calculate the amount to be withheld or you can use the supplemental tax rate of 25%. That’s for federal income tax. Either way, you’ll also need to deduct social security and medicare and pay the matching taxes as well.
If you wait until the very last minute – January 31st – to do this, then you’ll need to process a supplemental payroll with a 12/31 (of the prior year) check date so you can get these on your 4th quarter form 941. If you are a daily, semi-weekly or monthly depositor of your 941 tax then those taxes will be late.
What you’re supposed to do is figure it all out before 12/31, even if you have to estimate the amount, run it through payroll and pay the tax on time. Then you have until 1/31 to come up with the actual amount and make adjustments before you issue the W-2s.
If you can’t get the calculations done by 12/31 then you could invoke the special account rule and shift the November and December amounts to the following year. So the value of the last two months can be treated as having been provided in the following year. Only the value of benefits ACTUALLY PROVIDED during the last two months can be treated this way.
Fringe Benefit examples:
- Accident and health benefits
- Achievement awards
- Adoption assistance
- Athletic facilities
- Bicycle commuting reimbursement
- Commuter highway vehicle
- De minimis (minimal) benefits
- Dependent care assistance
- Educational assistance
- Employee discounts
- Employee stock options
- Employer-provided cell phones
- Gift cards
- Group-term life insurance coverage
- Health savings accounts (HSAs)
- Lodging on your business premises
- Moving expense reimbursements
- No-additional-cost services
- Outplacement services
- Retirement planning services
- Transit pass
- Tuition reduction
- Working condition benefits