Imputed income: definition and guide

Offering fringe benefits, like a company car or tuition assistance, can be a great way to improve employee engagement and attract and retain talent. However, these non-cash benefits may be considered part of the employee’s total compensation and, thus, subject to taxation. When that happens, employers must follow imputed income tax rules.

What is imputed income?

Imputed income is the cash value of any non-cash, fringe benefits that employees receive. This amount is added to the employee’s gross income and reported on Form W-2, Wage and Tax Statement. Employers may have to withhold federal income tax and Federal Insurance Contribution Act (FICA) taxes from imputed pay, though exclusions apply.

Examples of fringe benefits and imputed tax income

Any benefit not qualified under a cafeteria plan may be considered a fringe benefit. Some examples include:

• Archer MSAs
• Athletic facilities and gym membership
• Educational assistance
• Employee discounts
• Employer-provided cell phones
• Lodging on business premises
• Meals
• No-additional-cost services
• Retirement planning services
• Transportation or commuting benefits
• Tuition reduction
• Working condition benefits

Not all of these employee benefits are taxed as imputed income in all circumstances. Ultimately, taxation depends on whether the fringe benefit meets certain exclusionary criteria.

What are imputed earnings and what is excluded?

IRS Publication 15-B, Employer’s Tax Guide to Fringe Benefits provides detailed instructions on how to determine if a fringe benefit should be considered imputed income. In general, de minimis, or minimal benefits, and working condition benefits are not taxable income. Other fringe benefits may be tax exempt depending on the circumstances in each case.

De minimis benefits

Any property or service offered to employees that has such minimal value it would be unreasonable or impractical to account for it is a de minimis benefit. Examples include:

• Personal use of phones provided by employers for uncompensated business purposes
• Occasional personal use of a copy machine that is used for business purposes at least 85% of the time
• Holiday or birthday gifts, excluding cash, with a low fair market value
• Flowers, fruits and similar items given to employees under special circumstances, e.g., illness family crisis, etc.
• Group-term life insurance payable on the death of an employee's spouse or dependent if the face amount is less than $2,000
• Certain meals
• Occasional parties or picnics for employees and their guests
• Occasional tickets for theater or sporting events
• Certain types of transportation fare

Working condition benefits

Working condition benefits are services or property provided to employees so they can perform their jobs. They are excluded from imputed earnings as long as the property or service would be considered a business expense or depreciation expense deduction if the employee had paid for it. The employee must meet any substantiation requirements that apply to the deduction.

Some examples of working condition benefits include:

• Employee use of a company car for business purposes
• Cell phones provided by the employer primarily for uncompensated business purposes
• Job-related education

Exempt benefits with financial limitations

Some fringe benefits are tax free up to a financial limit, after which they become imputed income. These include:

• Achievement awards
• Dependent care assistance
• Educational assistance
• Employee discounts
• Group-term life insurance coverage
• Health savings accounts (HSAs)
• Transportation benefits

Employee exemptions

Whether a fringe benefit is treated as imputed tax income sometimes depends on the employee’s role in the company. For example, lodging on business premises is generally tax exempt if it’s done for the employer’s convenience and is a condition of employment. This exemption does not apply to S corporation employees who are 2% shareholders.

Highly compensated employees may also be excluded from some imputed income exemptions, particularly if a fringe benefit favors them and isn’t available on the same terms to other employees. This rule only applies to certain benefits, such as no-additional-cost services, tuition reduction and adoption assistance.

How to determine the value of fringe benefits

If a fringe benefit offered to an employee is imputed income, the employer must determine its cash value so it can be properly taxed. The general valuation rule applies in most cases. It relies on the fair market value (FMV), which is the amount an employee would have to pay a third party to buy or lease the benefit in question.

When applying this rule, employers must consider all the facts and circumstances available to them. The costs they incurred to provide the fringe benefit and what the employee thinks the benefit is worth do not determine FMV.

Special valuation rules

The valuation of employer-provided vehicles can be determined using the general valuation rule, as well as the cents-per-mile rule, commuting rule or lease value rule if all requirements are met. Special valuation rules also apply to meals provided at employer-operated eating facilities and aircraft usage. Employers should refer to IRS regulations for further details.

Withholding imputed income taxes

Employers must withhold the applicable income tax and FICA taxes from imputed income on the date or dates they choose to treat the fringe benefits as paid. There are two withholding methods for income tax:

1. Add imputed income to an employee’s normal taxable wages for the payroll period and calculate income tax withholding on the total.
2. Withhold income tax on the imputed income at the flat 22% rate that applies to supplemental wages.

Note: If the supplemental wages paid to an individual employee exceed $1 million for the year, employers must calculate imputed income tax using the flat 37% rate rather than the 22% rate.

Reporting imputed income taxes

Employers are required to report imputed income earned by an employee during the calendar year by January 31 of the following year. Form 941, Employer’s Federal Quarterly Tax Return (or Form 943, 944 or CT-1) and Form W-2 may be used for this purpose.

Filing a separate Form W-2 dedicated to fringe benefits and other benefit information is an available option. Total imputed income earned by an employee during the calendar year is reported in box 14 on the tax form.

FAQs: Imputed income tax implications

How does imputed income affect an employee's federal tax return?

Imputed income is taxable. As such, employees may have to pay taxes (federal income tax and Medicare and Social Security taxes) on any fringe benefits they receive from their employer that are not tax exempt.

Where can I find imputed income on my paycheck?

Examples of imputed income can typically be found under the “employer paid benefits” section of a pay stub. Fringe benefits that are subject to taxes may be noted with an asterisk.

Does imputed income affect gross income?

Imputed income increases gross income and the amount subject to taxes. This total is reported in box 1 on Form W-2.

Where can I find more information on imputed income?

Comprehensive information on imputed income is available in IRS Publication 15-B, Employer’s Tax Guide to Fringe Benefits. Employers can also consult a licensed tax attorney if they offer any fringe benefits that might be considered imputed income.

What is domestic partner imputed income?

Group health coverage provided through a qualified cafeteria plan is generally exempt from taxation. However, if employees add non-dependent domestic partners to their plan, the cash value of the extended coverage may be treated as imputed income.

This guide is intended to be used as a starting point in analyzing the imputed income meaning and is not a comprehensive resource of requirements. It offers practical information concerning the subject matter and is provided with the understanding that ADP is not rendering legal or tax guidance or other professional services. Please consult with your legal counsel.