Imputed income refers to the value of benefits or non-cash compensation that is considered income for tax purposes, even though the individual did not receive a direct cash payment. Simply put, imputed income is the taxable value of something other than cash that the employee receives as a personal benefit.
Examples of Imputed Income
Imputed income can take several forms, depending on the types of non-cash compensation or fringe benefits an employer provides. Here are some common examples that employees may receive as fringe benefits that would count towards imputed income:
- Company Car or Car Allowances: If an employee is given use of a company car or paid an allowance for a car that is also used for personal reasons, the value of that personal use is considered imputed income.
- Group-Term Life Insurance: If an employer provides group-term life insurance coverage that exceeds $50,000, the cost of premiums for the amount above $50,000 is considered imputed income.
- Discounted or Free Housing: If an employer provides housing at a discounted rate or for free, the value of that benefit may be considered imputed income. There are various taxation exceptions as it relates to housing, however. For example, housing provided on company premises or if the employee must accept the housing as a condition of employment may be tax exempt and not count towards imputed income.
- Employee Awards and Prizes: When If an employer gives out non-cash prizes or awards, the value of these awards may be considered imputed income unless they are considered de minimis fringes, and the employee may be taxed on them.
- Forgiveness of Debt: In general, any canceled debt that is legally owed must be reported as income. In most cases, if an employer forgives a debt that an employee owes them, the amount of the forgiven debt is often considered imputed income.
- Educational Assistance: If an employer provides educational assistance that exceeds the IRS limit (which was $5,250 at the time of this writing), the amount over $5,250 is generally considered imputed income.
Benefits Exempted from Imputed Income
While many fringe benefits or non-cash compensations can count as imputed income, there are exceptions where certain benefits are not counted as such according to IRS regulations.
Here are some examples of fringe benefits that are generally exempted:
- Health Insurance: Employer contributions to employee health insurance are typically not considered imputed income and are excluded from gross income.
- Retirement Plan Contributions: Employer contributions to qualified retirement plans, such as a 401(k), are typically not considered imputed income.
- De Minimis Benefits: These are benefits of so little value (taking into account how frequently you provide similar benefits to your employees) that accounting for them would be unreasonable or administratively impracticable. Examples of de minimis benefits include occasional tickets for theater or sporting events, some holiday gifts, coffee, doughnuts, soft drinks, etc. It is important to note, however, that any cash award (or gift certificate), no matter how small, is not exempted from imputed income.
- Dependent Care Assistance: Up to certain limits, the value of employer-provided child care services or assistance is not considered imputed income. At the time of this writing, up to $5,000 in dependent care expenses provided by the employer are exempted from taxation.
- Educational Assistance: If an employer provides educational assistance up to $5,250, this is not generally considered imputed income. Amounts above this limit may be considered imputed income and employees may be subject to taxation.
- Certain Employee Awards: Non-cash awards for length of service or safety achievement are generally not considered imputed income, subject to certain conditions and limits.
- Business Expense Reimbursements: If an employee incurs an expense while performing their job, and the employer reimburses them for that expense under an accountable plan, the reimbursement is typically not considered imputed income because it is a non-personal expense.
Neither list are exhaustive but cover the most common forms that employers tend to face. It is always important to consult with a tax professional when dealing with imputed income to ensure proper tax calculation and reporting.
Unintended Consequences of Employee Awards:
Imputed income increases an employee’s total taxable income, meaning they will owe more in taxes. Employers and managers must be mindful when providing these types of benefits because what may initially appear as a generous perk or benefit may not feel as advantageous once the employee realizes the tax implications.
Minimizing Tax Implications for Employees
Imputed income can result in higher taxes for employees due to the increased taxable income. However, there are ways that companies can offset the tax burden for their employees:
- Grossing Up: Grossing up is one of the most common and easiest approaches that an employer may take to ensure that an employee award doesn’t feel like a penalty. Grossing up involves increasing the total amount of the employee’s payment to cover the tax liability from a particular benefit. For example, if a benefit receives a Sony TV with an imputed income value of $1000, and the employee is in the 22% tax bracket, the employer could pay the employee an additional $220 ($1000 * 22%) to cover the tax liability. The drawback here is that the additional payment is also taxable, so the calculation becomes more complicated and often requires iterative calculations to reach the accurate gross-up amount.
- Reclassification: In some cases, it may be possible to reclassify a benefit, exempting it from being considered imputed income. This approach has limits and requires strict compliance with IRS guidelines.
- Changing Benefit Structure: The employer can replace the benefits that create a significant amount of imputed income with alternative forms of compensation that do not have such tax implications. For example, instead of providing a company car (which can result in imputed income), they may offer a transportation allowance or a higher salary. Changing the benefits structure will have pros and cons. While cash is great, it does little to support company culture and create benefits that are personalized or meaningful to the employee.
- Use of Pre-tax Dollars: Certain types of benefits, like retirement contributions or health savings accounts, are funded with pre-tax dollars. Increasing these types of benefits could offset the tax impact of imputed income.
None of these recommendations should be considered legal or tax advice. Tax code is complex, and the best approach depends on many factors, including the specifics of the benefit, the employee’s tax situation, and the financial resources of the employer, the state, city, and country. It’s crucial to consult with a tax professional to ensure any strategy to offset the taxes associated with imputed income is compliant with current tax laws and beneficial for both the employee and the employer.
Considerations for Compensation Analysts
While the Total Rewards Professional may weigh various options to create attractive compensation packages that recruit, retain and engage employees they must take into account the tax implications. Whether designing executive pay packages or creating commuter benefits programs for all employees, if the significantly increases an employee’s taxable income, the value to employees may be diminished.
Compensation Analysts need to communicate clearly about imputed income to employees, so they understand the value and tax implications of their total compensation package. Companies that offer benefits packages with significant imputed income could be seen as less attractive compared to others that offer similar packages without these tax implications.
While fringe benefits can greatly shape an organization’s culture and imputed income from can be a useful tool for creating comprehensive and attractive compensation packages, unintended consequences must be considered. The benefits should be perceived as having value to employees, without causing excessive tax burdens.