Benefits and perks beyond salary or wages can be valuable for enhancing employee satisfaction but the IRS has strict guidelines on their taxation—and a strict January 31 deadline for reporting them on employees’ W-2 forms. One area of concern is the question of which fringe benefits must be reported as income. Some are frequently misreported, leading to avoidable compliance risks and potential penalties.

Fringe Benefit Fundamentals

As a general rule, fringe benefits are reportable as income unless the Internal Revenue Code specifically excludes them. Some of the best-known exclusions include employee accident and health benefits, group term life insurance, and health savings account (HSA) contributions for qualified individuals up to certain limits.

The code also exempts achievement awards, employee educational assistance, and dependent care assistance—again up to certain limits—as well as the use of employer-provided cell phones if they are provided primarily for business purposes. De minimis benefits can be excluded if their value is so low that accounting for them would impose an unreasonable administrative burden, but the code does not spell out a specific dollar amount to determine if a benefit qualifies.

IRS Publication 15-B, Employer’s Tax Guide to Fringe Benefits (https://www.irs.gov/publications/p15b#en_US_2024_publink1000193639), offers detailed explanations of the proper tax treatment and reporting requirements for various types of fringe benefits, including a table that summarizes the exclusions.

Among the numerous perks employers provide to employees, two groups of benefits merit special attention because they are so frequently misreported: employees’ personal use of company cars, and health insurance and other benefits for S corporation shareholder-employees.

Personal Use of a Company Car

Providing an employee with access to a company vehicle incurs some specific tax reporting requirements. Any personal use of a company car— such as commuting between home and work, running personal errands, or using the vehicle on weekends—is considered a taxable fringe benefit and must be included as wages on the employee’s W-2.

The IRS permits employers to use one of several valuation methods to calculate the taxable value of an employee’s personal use of a company car:

• General Valuation Rule: The fair market value (FMV) of personal use of a vehicle is based on what it would cost to lease or rent a comparable car for the same period.
• Cents-Per-Mile Method: Employers can value personal use at a standard mileage rate (67 cents per mile for miles driven in 2024, 70 cents per mile in 2025) if the vehicle is used regularly for business and driven at least 10,000 miles annually.
• Commuting Rule: A simplified method allows employers to value personal use at $1.50 per one-way commute ($3.00 round trip) if the car is used solely for commuting and the employee is required to commute in a company car for valid business reasons.
• Annual Lease Value Method: The taxable value is determined using an IRS-provided table of lease values based on the car’s FMV. The taxable amount is then prorated based on the percentage of personal use.

Employers must choose an appropriate method at the start of the year and apply it consistently for the entire tax year. Regardless of the method chosen, accurate record-keeping, such as a log or mileage tracking tool, is essential to document and substantiate the vehicle’s business and personal use.

There are two ways an employer can avoid this reporting requirement:

• Having the employee reimburse the employer for the personal use value; or
• Rather than providing company vehicles, reimbursing employees for the business use of their personal vehicles instead. However, providing a reimbursement allowance without accounting for actual business use will result in the allowance being treated as taxable income to the employee.

Health Insurance Benefits for S Corporation Employee-Shareholders

As mentioned earlier, health insurance premiums for employees are typically excluded from taxable wages, but the rules are different for S corporation shareholder-employees who own more than two percent of the company’s stock. For these individuals, company-provided health insurance premiums are subject to federal income tax, but not subject to Social Security or Medicare taxes.

This means the premiums must be included in the shareholder-employee’s gross wages as reported in Box 1 of Form W-2 but should not be included in Box 3 (Social Security wages) or Box 5 (Medicare wages). The premiums also should be disclosed in Box 14.

Although their health insurance premiums are included in gross wages, S corporation shareholder-employees generally can take an above-the-line deduction for these premiums on their personal returns. This is permitted if the corporation either pays the premiums directly or reimburses the shareholder for the costs, as long as the shareholder is not eligible for other health insurance such as coverage through a spouse’s employer.

Note that under the IRS’s stock ownership attribution rules, a shareholder’s family members are also treated as shareholders, even if they do not own stock themselves. Thus, if an S corporation employs a shareholder’s spouse, children, grandchildren, or parents, those related employees’ health insurance premiums must also be reported as taxable income. Certain other fringe benefits (such as group term life insurance, achievement awards, HSA contributions, and benefits offered in cafeteria plans) are also treated differently for S corporation shareholder-employees and their family members.

Compliance with these complex rules can be challenging, but accurate and timely reporting of fringe benefits is essential since it affects both the employee’s income taxes and the employer’s payroll taxes. With the January 31 reporting deadline approaching, companies should work closely with their tax professionals to avoid penalties and ensure accurate fringe benefit reporting. Please reach out to Holbrook & Manter with any questions you may have.