Benefit Plans: Tax Considerations
Employee benefits can be complex to administer, particularly in terms of taxation. It is important to understand the tax implications for both the employer and employee. This article will explain the general considerations related to the taxation of employee benefits.
Employer Tax Implications:
Employers can usually deduct amounts that they spend on employee benefits as a trade or business expense when filing taxes. In order to be deductible as a trade or business expense, the expense must meet the following criteria:
It is an ordinary and necessary expense of the employer’s trade or business – The IRS defines “ordinary” as common and accepted in your trade or business. A “necessary” expense is one that is helpful and appropriate for your business; it need not be indispensable to be considered necessary.
The expense must be paid or incurred during the tax year in which it is deducted – This depends on whether your company uses a cash method or accrual method of accounting. If using a cash method, the expense is deductible in the year it is paid. If accrual method is used, the expense is deductible in the year it is incurred.
The expense must be connected with the trade or business conducted by the taxpayer (employer). – This requirement simply differentiates a business with a primary purpose of achieving income or profit from a sporadic hobby or activity that happens to make money.
It is also important to remember for noncash benefits that the employer may deduct only the cost of the benefit (though the value of the benefit must be included in the employee’s gross income).
The employer is also responsible for determining if various benefits should be included in the employee’s’ gross income for tax purposes. Generally, a benefit must be included in the employee’s taxable income unless specifically excluded by the IRS. Many employee benefits are expressly excluded from gross income by the IRS, including health insurance, life insurance (up to a limit), education assistance, flexible spending accounts, child care expenses, legal assistance and more. Visit www.irs.gov for a complete list.
Contact us for further guidance on tax considerations.