By Jane M. Searing, CPA, M.S. Taxation | Clark Nuber PS
Certain transportation and onsite health benefits have been tax exempt to employees and tax deductible to employers prior to passing the Tax Cuts and Jobs Act of 2017. However, beginning January 1, 2018, the law subjects both for profit and nonprofit employers to taxation on these specific benefits as long as employers continue to treat the benefits as tax-free to employees.
Therefore, employers must make an important business and economic choice in relation to the benefits described below. They must decide whether to treat the benefit as taxable compensation to employees, or continue to treat the benefit as a non-taxable benefit to employees, but receive no income tax deduction for providing the benefit.
Because non-profit organizations do not pay income tax, loss of the tax deduction would not impact the decision to treat the benefits as taxable or non-taxable fringe benefits. Instead, the new tax law subjects the value of the benefits noted below to unrelated business income tax, assuming the employer continues to treat the benefits as non-taxable to employees.
Benefit Changes as of 2018
Which benefits are losing status as deductible to the employer, or non-taxable fringe benefits to the employee, depending on the employer’s decision?
- Qualified transportation and commuting fringe benefits associated under Internal Revenue Code section 132(f), including:
- Any transit pass
- Transportation in a commuter highway transportation vehicle between the employee’s residence and workplace paid by the employer
- Qualified parking as defined in IRC section 132(f)(5)(C).
- On-premises athletic facility as defined in IRC section 132(j)(4)(B).
Note the change in the tax law does not automatically result in these benefits being taxable to employees.
Rather, a nonprofit employer must make a choice either to treat the benefits as taxable compensation to employees, thereby avoiding unrelated business income tax treatment of the benefits, or continue to treat the benefit as non-taxable to its employees, but subject value of the benefit to unrelated business income tax.
The decision is a tax, business, economic and employee-relations decision. Some factors to consider in making this decision include:
- Under the new law, the corporate tax rate decreased from a maximum 35% to a flat 21% rate, while individual tax rates shifted only slightly.
- Also, newly taxable benefits should be assumed to be the last dollars taxed at the highest rate to which the employee is subject.
- Because the benefit is now taxable wages, both the employer and employee must pay employment taxes on the benefits at 7.65%, assuming the employee is not over the FICA limit.
- Also, nonprofit employers’ unrelated business income is now subject to segregation by trade or business. We do not know if the expense of paying unrelated business income tax on non-taxable employee benefits may offset any other unrelated business income tax to which the nonprofit organization may be subject.
What Should Employers Do?
The following is an illustration of the financial impact of the decision, and an explanation of the choice employers must make before the first payroll of 2018:
Facts: The value of the applicable benefits is $100,000. The employer does not have any deductions to offset the value of the benefits. The employer is a corporate non-profit with no other unrelated business income. The average employee is in the 25% marginal tax rate and employer/employee payroll taxes are each 7.65%.
Option 1: The nonprofit employer may continue to treat the benefits as non-taxable to its employees and pay unrelated business income tax on the value of the tax-free fringe benefits.
- Cost to employer: $100,000 cash for benefits and $21,000 in additional unrelated business income taxes; total paid $121,000
- Benefit to U.S. Treasury: $21,000
- Benefit to employees: $100,000
- Cost to employees: $0
Option 2: The nonprofit employer may treat the benefit as taxable wages, withhold income tax on the value of the benefit from the employees’ other wages, and pay the employer payroll taxes.
- Cost to employer: $100,000 + $7,650 = $107,650 Benefit + employer share of payroll taxes
- Benefit to U.S. Treasury: $25,000 + $7,650 + $7,650 = $40,300 (employee income tax plus total payroll taxes)
- Benefit to employees: $100,000
- Cost to employees: $25,000 + $7,650 = $32,650 Income tax + employee share of payroll taxes
- Net benefit to employee: $67,350
On a combined basis, the cost of paying the tax at the non-profit level at a tax rate of 21% with no employment taxes (option 1), as compared to transferring the tax burden to the employees at a tax rate of 25% with a combined payroll tax rate of over 15% (option 2), reflects a total tax differential of nearly 20%. The employee receives the same benefit but there is an overall tax cost to receiving the benefit of nearly twenty percent to the nonprofit employer and employee on a combined basis. The non-profit employer may be better off economically paying the unrelated income tax rather than subjecting the benefits to tax by the employees and paying the employer payroll taxes.
Each organization must decide which option is best based upon its facts and circumstances. Please contact Jane Searing at firstname.lastname@example.org if you have questions about how tax reform might affect your employee benefit plan, or visit our Tax Cuts and Jobs Act page for additional resources.
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