What is imputed income? Examples + tax implications

Did you know that some of the perks you provide your employees, like using a company car or a gym membership, might be increasing their taxable income? 

Even though employees don’t receive any actual money, they’re likely paying taxes on the value of fringe benefits, or imputed income. Understanding the tax impact of imputed income is crucial when financial planning, especially when employees aren’t expecting to pay them. 

Let’s explore what imputed income is, how it works, and what your employees should expect to see on their W-2s. 

How imputed income works

Types of imputed income

Benefits excluded from imputed income

Tips for managing imputed income

Next steps for streamlining your payroll process

Imputed income FAQ

How imputed income works 

Imputed income is the value of certain non-cash benefits employers provide, which the IRS says must be treated as taxable income. Even though employees don’t receive extra cash in hand, these benefits hold value and are therefore considered part of their income by tax authorities.

For that reason, you should be aware of what imputed income is because it can impact your overall tax liability. When an employee receives valuable benefits from their employer, such as a company car, gym membership, or even certain types of insurance coverage, the IRS considers them a form of compensation. 

The value of these perks must be added to your gross income, meaning that they are subject to payroll withholding.

Types of imputed income

There’s no shortage of benefits that can be considered imputed income. Always check the benefits to ensure you’re accounting for everything in your W-2 forms

Here are a few common types of fringe benefits that are taxable:

• Gym memberships: The value of that membership is considered imputed income because it has a cash value. While you are covering the cost of your employees’ membership, the membership itself is taxable. 
• Company car: When you let an employee drive a company car for personal errands or tips, the value of that personal use is imputed income because it’s unrelated to their job and saves them money on things like gas and wear and tear. The IRS requires you to calculate how much that personal use is worth and include it in their taxable income. 
• Health insurance for domestic partners: One key tax-related differentiator between marriage and domestic partnerships is imputed income on health benefits. If you provide health insurance that covers your employee’s domestic partner, and their partner is not their tax dependent, they must report the value of that coverage on their taxes. 
• Debt forgiveness: If you forgive a loan you took out for an employee, the amount forgiven is considered imputed income. In the eyes of the IRS, it’s like receiving a cash bonus because they are no longer obligated to repay the debt. 
• Company trips: If you offer an employee a trip that’s not business-related, like a vacation, the value of that trip is imputed income because they would otherwise be paying for it out of pocket. There are some exceptions to this rule, like if the trip is an educational conference or qualified moving expenses if they relocate for work. 

Real-life imputed income examples 

Here are some examples of fringe benefits that add to an employee’s total imputed income: 

• Gym memberships: Suppose you offer your employee a gym membership worth $600 per year. This $600 is considered imputed income and added to their taxable wages on their W-2. 
• Company-owned cars: If you allow your employee to use a company car for personal errands and weekend trips with a fair market value totaling $2,000 per year. This $2,000 is added to their taxable wages as imputed income, and the necessary taxes will be withheld. 
• Employer-provided housing: If you provide your employee with housing that has a fair market value of $10,000 per year, this amount is considered imputed income. 
• Employer-paid travel expenses: Let’s say you pay for $1,000 of your employee’s personal travel expenses, like a vacation or a family visit. These expenses are considered imputed income. 

These examples may seem like small amounts of money, but these benefits can add up over time!

Benefits excluded from imputed income

Here’s some good news: Not all fringe benefits are considered imputed income. Some of them are specifically excluded from taxation under IRS rules: 

Health insurance

The health insurance benefits that you provide for your employee, their spouse, and their dependents are usually not considered imputed income. Health insurance is considered essential for maintaining well-being and reducing their financial burden for medical expenses. 

By not taxing employer-sponsored health insurance, the government encourages employers to offer this crucial benefit and helps ensure more people have access to affordable care. 

Health savings account (HSA) contributions

Employer contributions to your employees’ HSAs are excluded from imputed income as long as they stay within IRS limits. 

HSAs help people save for future medical expenses on a tax-advantaged basis. By excluding these contributions from taxable income, the IRS promotes saving for healthcare costs, which can be a substantial financial burden. The exclusion makes it easier for employees to save for qualified medical expenses and reduce the financial strain related to healthcare.

Meals and lodging

When a company provides employees with meals and lodging for work purposes, such as when they’re required to live on-site or work in a remote location, these benefits are excluded from imputed income. This is because these benefits help enable them to perform their job effectively rather than for personal enjoyment. 

For example, suppose your employee is a nurse who has to stay on-site for an extended shift due to a natural disaster. In that case, you can cover their meals and lodging because they are necessary to perform the job adequately. 

Employer-provided education assistance

If you are paying for your employee’s tuition, books, or other education-related expenses, these benefits may be excluded from their taxable income up to a specific limit. The IRS allows employers to provide up to $5,250 per year in educational assistance to an employee without counting it as imputed income. 

The reason behind this exclusion is to encourage continuous learning and professional development, which benefits the employee and the employer. Educational assistance can help employees gain new skills, advance their careers, and stay competitive in the job market without increasing their tax liability. 

Dependent care assistance

A portion of dependent care assistance, like childcare or elder care services, may be excluded from your employee’s taxable income. The IRS allows them to exclude up to $5,000 per year for dependent care assistance under a qualified plan. 

Dependent care assistance helps working parents and caregivers manage care costs for their dependents while they work. By excluding this benefit, the IRS recognizes the importance of supporting families in balancing work and caregiving responsibilities. It makes it easier for employees who would otherwise bear the full tax burden of these necessary expenses. 

Tips for managing imputed income 

To simplify the process of managing fringe benefits, here are some steps you can take:

• Invest in payroll software: Using payroll software that automatically calculates and tracks imputed income can save you time and reduce errors. Typically, payroll software offers features that make managing all aspects of payroll easier, including fringe benefits. 
• Review fringe benefits regularly: Employers should review the imputed income they offer to ensure they comply with IRS rules and regulations. This includes calculating the fair market value of benefits and understanding which ones you need to report as imputed income. 
• Educate your team: You should fully train your human resources and payroll teams to handle imputed income. You should also inform your employees about how these benefits will affect their taxes so they don’t feel blindsided when tax season arrives.

Next steps for streamlining your payroll process

Managing imputed income and fringe benefits can be complex, but employers and employees need to get it right. 

Are you looking for ways to simplify payroll processes and ensure compliance with imputed income regulations? Explore the tools available with Quickbooks Payroll. Our payroll software serves as your comprehensive solution for your payroll management needs, so you can save time and stress when navigating imputed income. 

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