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What Is Imputed Income?
Many employers offer fringe benefits and prizes to employees in addition to their regular compensation. Such non-monetary benefits may be considered imputed income and can be taxable as though they had been given in cash.
Why It’s Important to Understand Imputed Income
Understanding imputed income is important to both employees and employers for the following reasons:
- No unpleasant surprises for employees. Employees need to understand what fringe benefits and awards are taxable to them so they can either ensure they have the appropriate federal tax withholding during the year or forgo a benefit they don’t need or want. Finding out about the tax consequences of a benefit after the fact can be frustrating to employees. It’s preferable to adjust withholding amounts on paychecks throughout the year than it is to come up with additional tax owed at tax time.
- Avoiding costly corrections and penalties for employers. Employers that fail to follow IRS guidelines for imputed income will have the added burden of correcting tax forms for each affected employee. Penalties are also assessed by the IRS for incorrectly calculating W-2 income. These penalties start at $50 and can be as high as $550 per form with no maximum limit.
Examples of Imputed Income
Several common examples of imputed income are personal use of a company vehicle, group term life insurance with a value over $50,000, gym memberships and fitness incentives (with more than a de minimis, or minor, value), the cost of health insurance for a domestic partner, nondeductible reimbursements for moving expenses and education assistance that is greater than the nontaxable amount. Let’s discuss a few of these in greater detail.
The IRS has determined that personal use of a company vehicle must be taxed. This involves a fairly complex calculation that assesses a value of the vehicle as though it were being leased from an outside company. Fortunately, the IRS provides resources that can help with these calculations.
Employers often offer term life insurance to employees. Policies with coverage up to $50,000 are not taxable to employees. The value of the policies over $50,000 becomes taxable. This can be challenging because the cost of the policies is typically age based, so the rates and imputed income assessments are determined by employee ages. Younger employees will pay less than older employees for the same amount of coverage. Most insurance companies will have tables that reflect the average monthly taxable income rates based on age to assist payroll departments in the imputed income calculations. Employees who don’t wish to have life insurance or who wish to cap it at $50,000 can ask their employers to work with them to eliminate any imputed income assessments. It’s also possible for employees to designate a charity as the sole beneficiary of such policies to avoid imputed income tax obligations.
Wellness benefits are highly valued by many employees. Some employers help to pay for gym memberships or offer incentives for participation in fitness programs. The cost of these benefits usually must be added to the gross pay of employees unless the actual cost is minimal (typically under $100 per year).
Many other types of non-cash benefits can be considered imputed income for tax purposes. Some employers may give gift cards as a reward for excellent performance. The amount of these gifts should be added to the employee’s gross income so appropriate taxes can be paid. Health insurance benefits paid by companies for domestic partners who aren’t considered dependents on an employee’s tax return must be calculated as imputed income. Generous employer contributions to dependent care, educational expenses and adoption assistance that exceed IRS limits will also be considered imputed income. In short, most employer benefits should be reviewed for possible tax obligations.
What Is Excluded from Imputed Income?
While most employer fringe benefits may fall into the category of imputed income, there are some exclusions.
De Minimis Benefits
Small gifts, typically for holidays or birthdays with a value less than $100, don’t need to be included in imputed income calculations. Likewise, the cost of company parties, occasional sporting events tickets, fruit baskets or floral arrangements and other entertainment or team building events can be excluded from taxable income.
Company logo items, such as shirts, hats, pens and water bottles, are typically excluded from imputed income requirements.
Company-provided cell phones, meals provided to employees during travel or for required meetings and health savings account contributions paid by employers are excluded from taxable income.
How To Report Imputed Income
Employers have several options when reporting imputed income. Some employees enter the value of the benefits for each employee each pay period. Others wait until the end of the year. As long as the income is reported annually, employers can choose the frequency.
Step 1 – Determine the Fair Market Value or Cost
The employer will determine the fair market value of the benefit in the case of employee use of a company car, or the employer will add the actual cost of the benefit to the gross payroll amount of an employee’s check.
Step 2 – Calculate the Taxes
Taxes will then be calculated on the gross wages for that paycheck. Please note that since the benefit has already been paid, the amount of the imputed income is not included in the net pay.
Step 3 – Show Imputed Income on Their W-2
At year-end, each employee’s W-2 form will reflect the total amount of imputed income.
It’s that simple! A good payroll software will make the process easy to implement. The IRS has a helpful publication that provides more information on taxation of imputed income: Publication 15 B: Employer’s Tax Guide to Fringe Benefit.
Questions You’ve Asked Us About Imputed Income
Who pays imputed income?
Some taxes on imputed income are paid by both employers and employees, such as Social Security and Medicare. Federal and state income taxes are the responsibility of the employee.
Is health insurance imputed income?
Health insurance is not typically considered imputed income. However, the amount the employer pays for an employee’s domestic partner or their children may be taxable if the domestic partner is not a dependent for tax purposes of the employee.
How do I calculate imputed income?
Fortunately, most payroll software programs will do this calculation automatically. Otherwise, the employer must manually add the taxable value to the gross income and deduct that amount from the net pay so the employee isn’t paid twice. The total amount of imputed income must also be reflected on employee W-2 forms.
Carol Eliason Nibley, SPHR, GPHR and Principal Consultant at PeopleServe, has more than 25 years of experience in human resources, most recently serving as Vice President of Human Resources for a technology company in Utah County. Carol has taught HR certificate courses at Mountainland Technical College and in other settings for more than 12 years.
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