Explain the Tax Implications  of Employee Fringe Benefits

Nothing sours an employee’s initial delight over a fringe benefit or freebie like being hit with an unanticipated tax bill.

Normal Benefits: It’s easy to explain that employee fringe benefits like a bonus, theater tickets or the use of a company automobile may be treated as taxable income subject to tax withholding. Nevertheless,  give the information upfront so employees can decline perks they cannot afford.

Stock Options: Stock options are more complicated. As this incentive moves down to lower employee ranks, it reaches precisely the younger or more financially naïve employees least able to afford a tax shock and most likely to misunderstand how to exercise options advantageously. Rather than viewing options as a long-term incentive to stay with a company, many employees believe options have immediate cash value that goes up over time. However, short-term gains are taxed at a much higher rate than long-term gains and employees are often stunned if they exercise their options at the first opportunity and then receive a hefty tax bill.

Other employees who exercise at the wrong time or during a down market may owe more in taxes than they made on the stock.  For example, one client exercised options on his employer resulting in almost $1 million in gain. The company went Bankrupt and the stock became worthless. Due to careful planning, payment of the tax was avoided, but the situation could have been disastorous.

Worst case scenario: A staff member faced with an unanticipated tax bill blames your company, negating any goodwill that the benefit was supposed to provide.

If your company offers stock options or other potentially valuable benefits as an incentive, don’t let the program backfire through employee ignorance or misunderstanding. Here are some tips:

 1. Offer education classes shortly after hire, when employees become familiar with the company and are beyond the flood of typical "new employee" information that may go in one ear and out the other.

 2. Explain the implications of benefits so employees are clearly informed about their risks and rewards.

 Remember to tell employees when a fringe benefit is tax-free. For example, the cost of up to $50,000 of group-term life insurance coverage provided by an employer is not included in income. Check with Ronald J. Cappuccio, J.D., LL.M.(Tax) at (856) 665-2121 for all the details.