It’s been reported that employees may receive raises of 5% or more this year as a way for employers to retain their staff in the face of the “great resignation.” Small business owners need to review compensation packages for employees and find ways to boost their offering without busting their budgets. Raising wages and giving cash bonuses may not be feasible. One way to give employees more without big outlays is through tax-advantaged fringe benefits, which allow employees to benefit from certain payments without being taxed on them while employers deduct the payments and avoid employment taxes on them. Another way—which costs the company only administrative costs—is to create arrangements where employees can pay for certain benefits they want on a pre-tax basis. Here are some options:
What benefits are tax free
Most fringe benefits (“perks”) are tax free to employees. Perhaps the most desired benefit is health coverage, which may be:
- Employer-paid group health coverage. Note: If certain conditions are met, small employers that buy the coverage through the government’s SHOP Marketplace may claim a tax credit which is even better than a deduction—for the premiums they pay.
- Reimbursements for personally-obtained coverage through a Qualified Small Employer Health Reimbursement Arrangement. The government sets the annual limit of reimbursements.
- Reimbursements for personally-obtained coverage under an Individual Coverage Health Reimbursement Arrangement (IBHRA). The company sets the limit on reimbursements.
- Reimbursements through an Excepted Benefit HRA. The annual limit for 2022 is $1,800.
- Employer contributions to employees’ health savings accounts. The employer must have a high-deductible health plan to make these deductible contributions.
Another much-desired benefit is retirement plan assistance. Employer contributions to for the benefit of employees are tax deductible by the company. If a small employer doesn’t yet have a retirement plan in place, there’s a tax credit for setting one up. And there’s another credit for opting to use an automatic enrollment 401(k) plan to put eligible employees into the plan unless they opt out or reduce the default salary reduction amount contributed to the plan. Other retirement plan assistance may be in the form of retirement plan counseling, which is another tax-free benefit to employees.
Examples of other tax-free fringe benefits include employer contributions to employees’ retirement accounts, dependent care assistance (up to a set limit), group-term life insurance up to $50,000, company discounts, paying student loans under an education assistance plan up to $5,250 annually through 2025, and usually reimbursements for business-related costs. For example, you may reimburse remote workers for the cost of their internet access at home. This will be tax free to them, while deductible by the company (and not subject to employment tax), as long as it’s done under an arrangement called an accountable plan.
Transportation fringe benefits, including free parking, transit passes, and van pooling, are also tax free to employees up to set monthly limits. However, employers may not deduct the cost of free parking.
A complete list of employee benefits may be found in IRS Publication 15-B (the dollar limits are slightly higher for certain benefits in 2022).
What benefits can be offered on a pre-tax basis
Instead of the employer paying for a particular benefit, an arrangement called a cafeteria plan enables the employee to pay on a pre-tax basis. A cafeteria plan enables employees contribute a portion of their compensation (limitations apply) and use the funds to pay the expenses of their choice within the terms of the plan. The employer bears the administrative cost for the plan. Depending upon how payroll is handled—in house, a CPA, or a payroll company—the cost may vary considerably. Still, this cost is less than having to pay for the benefit directly. And small employers may use a simple cafeteria plan, which helps to minimize compliance costs.
The cafeteria plan may be:
- A simple cafeteria plan for small employers. This allows employees to add a set amount of their compensation (limits apply) and then choose from a menu of benefits.
- A premium only plan. This is used to pay the premiums for the company’s group health coverage.
- A flexible spending account (FSA). This is used to pay for out-of-pocket medical expenses not covered by insurance and dependent care costs. There are annual dollar limits on what employees can put into the FSA; the limits differ for health and dependent care purposes.
A pre-tax arrangement can also be used to enable employees to pay for their personal commuting costs—parking or transit passes. Again, limits apply.
What benefits aren’t tax-advantaged
Employers may want or need to offer certain benefits that lack tax advantages of benefits described above. For example, if you want to help pay relocation costs for employees, you must treat this as additional compensation, which is deductible but subject to employment taxes; the benefit isn’t tax free to employees. The same is true if you allow employees to drive company vehicles for personal purposes.
Employers need to dig deep now and find ways to attract and retain employees. This is especially challenging for small businesses with limited budgets. Talk to your CPA or payroll company to see what you can do about expanding compensation packages.