Important Changes

Cents-per-mile rule.   The standard mileage rate you can use under the cents-per-mile rule to value the personal use of a vehicle you provide to an employee in 2002 is 36.5 cents a mile. See Cents-Per-Mile Rule in section 3.

Increase in public transit subsidy.   Beginning January 1, 2002, the maximum benefit an employee may exclude for combined commuter highway vehicle transportation and transit passes increases to $100. See Qualified Transportation Benefits in section 2.

Extension and expansion of exclusion for educational assistance plans.   The exclusion for educational assistance has been extended to years after 2001. Expenses for graduate level courses may be excluded for courses beginning after 2001. See Educational Assistance in section 2.

Increase in adoption plan exclusion.   Beginning with 2002, the amount of payments and reimbursements that can be excluded under an adoption assistance plan increases to $10,000 for each eligible child. This amount also applies to special needs adoptions. For more information, see Adoption Assistance in section 2.

Introduction

This publication supplements Publication 15, Circular E, Employer's Tax Guide, and Publication 15-A, Employer's Supplemental Tax Guide. It contains specialized and detailed information on the employment tax treatment of fringe benefits.

1. Fringe Benefit Overview

A fringe benefit is a form of pay for the performance of services given by the provider of the benefit to the recipient of the benefit. For example, you provide an employee a fringe benefit when you allow the employee to use a business vehicle to commute to and from work.

Performance of services.   A person who performs services for you does not have to be your employee. A person may perform services for you as an independent contractor, partner, or director. Also, for fringe benefit purposes, treat a person who agrees not to perform services (such as under a covenant not to compete) as performing services.

Provider of benefit.   You are the provider of a fringe benefit if it is provided for services performed for you. You may be the provider of the benefit even if it was actually furnished by another person. You are the provider of a fringe benefit your client or customer provides to your employee for services the employee performs for you.

Recipient of benefit.   The person who performs services for you is the recipient of a fringe benefit provided for those services. That person may be the recipient even if the benefit is provided to someone who did not perform services for you. For example, your employee may be the recipient of a fringe benefit you provide to a member of the employee's family.

Are Fringe Benefits Taxable?

Any fringe benefit you provide is taxable and must be included in the recipient's pay unless the law specifically excludes it. Section 2 discusses the exclusions that apply to certain fringe benefits. Any benefit not excluded under the rules discussed in section 2 is taxable.

Including taxable benefits in pay.   You must include in a recipient's pay the amount by which the value of a fringe benefit is more than the sum of the following amounts.

1. Any amount the law excludes from pay.
2. Any amount the recipient paid for the benefit.

The rules used to determine the value of a fringe benefit are discussed in section 3.

If the recipient of a taxable fringe benefit is your employee, the benefit is subject to employment taxes and must be reported on Form W-2. However, you can use special rules to withhold, deposit, and report the employment taxes. These rules are discussed in section 4.

If the recipient of a taxable fringe benefit is not your employee, the benefit is not subject to employment taxes. However, you may have to report it on one of the following information returns.

If the recipient receives the benefit as:	Use:
An independent contractor	Form 1099-MISC
A partner	Schedule K-1 (Form 1065)
An S corporation shareholder	Schedule K-1 (Form 1120S)

Cafeteria Plans

A cafeteria plan is a written plan that allows your employees to choose between receiving cash or taxable benefits instead of certain qualified benefits for which the law provides an exclusion from wages. If an employee chooses to receive a qualified benefit under the plan, the fact that the employee could have received cash or a taxable benefit instead will not make the qualified benefit taxable.

Generally, a cafeteria plan does not include any plan that offers a benefit that defers pay. However, a cafeteria plan can include a qualified 401(k) plan as a benefit. Also, certain life insurance plans maintained by educational institutions can be offered as a benefit even though they defer pay.

Qualified benefits.   Qualified benefits include the following benefits discussed in section 2.

• Accident and health benefits (but not medical savings accounts or long-term care insurance).
• Adoption assistance.
• Dependent care assistance.
• Group-term life insurance coverage (including costs that cannot be excluded from wages).

Benefits not allowed.   A cafeteria plan cannot include the following benefits discussed in section 2.

• Archer medical savings accounts.
• Athletic facilities.
• De minimis (minimal) benefits.
• Educational assistance.
• Employee discounts.
• Lodging on your business premises.
• Meals.
• Moving expense reimbursements.
• No-additional-cost services.
• Scholarships and fellowships.
• Transportation (commuting) benefits.
• Tuition reduction.
• Working condition benefits.

It also cannot include scholarships or fellowships (discussed in Publication 520, Scholarships and Fellowships).

Employee.   For these plans, treat the following individuals as employees.

1. A current common-law employee (see Circular E for more information).
2. A full-time life insurance agent who is a current statutory employee.
3. A leased employee who has provided services to you on a substantially full-time basis for at least a year if the services are performed under your primary direction or control.

Exception for S corporation shareholders.   Do not treat a 2% shareholder of an S corporation as an employee of the corporation. A 2% shareholder for this purpose is someone who directly or indirectly owns (at any time during the year) more than 2% of the corporation's stock or stock with more than 2% of the voting power.

Plans that favor highly compensated employees.   If your plan favors highly compensated employees as to eligibility to participate, contributions, or benefits, you must include in their wages the value of taxable benefits they could have selected. A plan you maintain under a collective bargaining agreement does not favor highly compensated employees.

A highly compensated employee for this purpose is any of the following employees.

1. An officer.
2. A shareholder who owns more than 5% of the voting power or value of all classes of the employer's stock.
3. An employee who is highly compensated based on the facts and circumstances.
4. A spouse or dependent of a person described in (1), (2), or (3).

Plans that favor key employees.   If your plan favors key employees, you must include in their wages the value of taxable benefits they could have selected. A plan favors key employees if more than 25% of the total of the nontaxable benefits you provide for all employees under the plan go to key employees. However, a plan you maintain under a collective bargaining agreement does not favor key employees.

A key employee during 2002 is generally an employee who is either of the following:

1. An officer having annual pay of more than $130,000.
2. An employee who for 2002 was either of the following:
   1. A 5% owner of your business.
   2. A 1% owner of your business whose annual pay was more than $150,000.

Form 5500.   If you maintain a cafeteria plan, you must report information about the plan each year by the last day of the 7th month after the plan year ends. Use Form 5500, Annual Return/Report of Employee Benefit Plan, and Schedule F (Form 5500). See the form instructions for information on extensions of time to file.

More information.   For more information about cafeteria plans, see section 125 of the Internal Revenue Code and the related regulations.

2. Fringe Benefit Exclusion Rules

This section discusses the exclusion rules that apply to fringe benefits. These rules exclude all or part of the value of certain benefits from the recipient's pay.

The excluded benefits are not subject to federal income tax withholding. Also, in most cases, they are not subject to social security, Medicare, or federal unemployment tax and are not reported on Form W-2.

This section discusses the exclusion rules for the following fringe benefits.

• Accident and health benefits.
• Achievement awards.
• Archer medical savings accounts.
• Athletic facilities.
• De minimis (minimal) benefits.
• Dependent care assistance.
• Educational assistance.
• Employee discounts.
• Employee stock options.
• Group-term life insurance coverage.
• Lodging on your business premises.
• Meals.
• Moving expense reimbursements.
• No-additional-cost services.
• Transportation (commuting) benefits.
• Tuition reduction.
• Working condition benefits.

See Table 2-1 for an overview of the employment tax treatment of these benefits.

Table 2–1. Overview of Employment Tax Treatment of Fringe Benefits

Accident and Health Benefits

This exclusion applies to contributions you make to an accident or health plan for an employee, including the following:

• Contributions to the cost of accident or health insurance.
• Contributions to a separate trust or fund that provides accident or health benefits directly or through insurance.
• Contributions to Archer MSA's (discussed in Publication 969, Medical Savings Accounts (MSAs)).

This exclusion also applies to payments you make (directly or indirectly) to an employee, under an accident or health plan for employees, that are either of the following:

• Payments or reimbursements of medical expenses.
• Payments for specific injuries or illnesses (such as the loss of the use of an arm or leg). The payments must be figured without regard to any period of absence from work.

Accident or health plan.   This is an arrangement that provides benefits for your employees, their spouses, and their dependents in the event of personal injury, or sickness. The plan may be insured or noninsured and does not need to be in writing.

Employee.   For this exclusion, treat the following individuals as employees.

1. A current common-law employee.
2. A full-time life insurance agent who is a current statutory employee.
3. A retired employee.
4. A former employee that you maintain coverage for based on the employment relationship.
5. A widow or widower of an individual who died while an employee.
6. A widow or widower of a retired employee.
7. For the exclusion of contributions to an accident or health plan, a leased employee who has provided services to you on a substantially full-time basis for at least a year if the services are performed under your primary direction or control.

Exception for S corporation shareholders.   Do not treat a 2% shareholder of an S corporation as an employee of the corporation for this purpose. A 2% shareholder is someone who directly or indirectly owns (at any time during the year) more than 2% of the corporation's stock or stock with more than 2% of the voting power.

Exclusion from wages.   You can generally exclude the value of accident or health benefits you provide to an employee from the employee's wages.

Exception for certain long-term care benefits.   You cannot exclude contributions to the cost of long-term care insurance from an employee's wages subject to federal income tax withholding if the coverage is provided through a flexible spending or similar arrangement. This is a benefit program that reimburses specified expenses up to a maximum amount that is reasonably available to the employee and is less than 5 times the total cost of the insurance. However, you can exclude these contributions from the employee's wages subject to social security, Medicare, and federal unemployment taxes.

S corporation shareholders.   Because you cannot treat a 2% shareholder of an S corporation as an employee for this exclusion, you must include the value of accident or health benefits you provide the employee in the employee's wages subject to federal income tax withholding. However, you can exclude the value of these benefits, other than payments for specific injuries or illnesses, from the employee's wages subject to social security, Medicare, and federal unemployment taxes.

Exception for highly compensated employees.   If your plan is a self-insured medical reimbursement plan that favors highly compensated employees, you must include all or part of the amounts you pay to these employees in their wages subject to federal income tax withholding. However, you can exclude these amounts, other than payments for specific injuries or illnesses, from the employee's wages subject to social security, Medicare, and federal unemployment taxes.

A self-insured plan is a plan that reimburses your employees for medical expenses not covered by an accident or health insurance policy.

A highly compensated employee for this exception is any of the following individuals.

1. One of the five highest paid officers.
2. An employee who owns (directly or indirectly) more than 10% in value of the employer's stock.
3. An employee who is among the highest paid 25% of all employees, other than those who can be excluded from the plan.

For more information on this exception, see section 105(h) of the Internal Revenue Code and the related regulations.

Achievement Awards

This exclusion applies to the value of any tangible personal property you give to an employee as an award for either length of service or safety achievement. The exclusion does not apply to awards of cash, cash equivalents, gift certificates, or other intangible property such as vacations, meals, lodging, tickets to theater or sporting events, stocks, bonds, and other securities. The award must meet the requirements for employee achievement awards discussed in chapter 2 of Publication 535, Business Expenses.

Employee.   For this exclusion, treat the following individuals as employees.

1. A current employee.
2. A former common-law employee that you maintain coverage for in consideration of or based on an agreement relating to prior service as an employee.
3. A leased employee who has provided services to you on a substantially full-time basis for at least a year if the services are performed under your primary direction or control.

Exception for S corporation shareholders.   Do not treat a 2% shareholder of an S corporation as an employee of the corporation. A 2% shareholder is someone who directly or indirectly owns (at any time during the year) more than 2% of the corporation's stock or stock with more than 2% of the voting power.

Exclusion from wages.   You can generally exclude the value of achievement awards you give to an employee from the employee's wages if their cost is not more than the amount you can deduct as a business expense for the year. That amount is $1,600 ($400 for awards that are not qualified plan awards). See chapter 2 of Publication 535 for more information on the limit on deductions for employee achievement awards.

To determine for 2002 whether an achievement award is a qualified plan award under the deduction rules described in Pub. 535, treat any employee who received more than $90,000 in pay for 2001 as a highly compensated employee.

If the cost of awards given to an employee is more than your allowable deduction, include in the employee's wages the larger of the following amounts.

• The part of the cost that is more than your allowable deduction (up to the value of the awards).
• The amount by which the value of the awards exceeds your allowable deduction.

You exclude the remaining value of the awards from the employee's wages.

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