Individuals have been feeling the pinch of the high tax brackets and phase-outs of deductions that came into place in 2012 with the introduction of the American Taxpayer Relief Act. The Act introduced the 39.6% tax bracket, the .9% Medicare tax on wages and brought back the phase-out of exemptions and itemized deductions. For individuals earning a high income, the addition of a new type of tax, a new tax bracket and limitations on deductions meant they could be subject to effective federal and state tax rates of close to 50%. In response to this, businesses have been increasingly turning to fringe benefit programs as a way to provide benefits to employees and reduce taxable income for both the employees and the business.
Win/Win for both the business and employees
Fringe benefit programs can provide a significant benefit for both the employees and the business by reducing the taxable income to the recipient and creating tax savings for the business. The ancillary benefit is creating an employee benefit that will retain highly qualified employees in a competitive labor market.
One example of how it works
Under a Dependent Care Assistance Program, an employee can set aside a portion of each paycheck tax free to pay for dependent care expenses (IRS regulations allow up to $5,000.00 per calendar year per family). Contributions are deducted from employee paychecks prior to federal, state and social security tax. For this example, let’s assume the employee is in the federal tax bracket of 28%, state tax bracket
of 6% and has a FICA rate of 7.65%. We will also assume the employer is subject to employment taxes of 10% for taxes such as employer FICA and state unemployment taxes. The Dependent Care Assistant Program will yield the following tax benefit to the employee and the medical practice:
Employee tax savings $5,000 x 41.65% = $2,082.50
Business tax savings $5,000 x 10% = $500
The reduction in employee taxable income could have other benefits as well. The reduction could decrease the phase-out of deductions and credits available on the employee’s tax return.
There are many different types of fringe benefit programs. All of them have different requirements and the utilization of benefits can depend upon the facts and circumstances such as the IRS entity classification of the medical practice. Here is a list of many of the most commonly used fringe benefit programs:
- Employer-provided educational assistance
- Accident and health benefits
- Athletic facilities
- Group term life insurance
- Meals for the convenience of the employer