To the extent that an employer can enable employees to pay for some personal needs on a pre-tax basis, both the employer and the staff win. The employer will save on employment taxes and may be able to curtail raises. The staff receives benefits they want with lower out-of-pocket costs to them. Here is an explanation of how this works and some examples that employers may want to consider:
Let’s say an employee needs to pay commuting costs on public transit to get to and from work. This cost isn’t deductible by the employee. If a monthly transit pass costs $120, the employee would have to earn about $160 if she were in the 25% tax bracket in order to cover income taxes and the employee’s share of FICA (even more if there are state income taxes). If the employer arranges for the pass to be purchased on a pre-tax basis, the $120 pass costs the employee $120. The $120 of her compensation is applied toward the pass and is not included in the W-2 income subject to federal income tax.
In addition to monthly transit passes or parking received in lieu of compensation, there are other pre-tax arrangements to consider.
Gone are the days when companies provided pensions for long-time employees. Now, for the most part, it’s up to workers to fund their own retirement savings. But this is facilitated by the employer setting up a certain qualified retirement plan. Employee contributions to 401(k) plans or SIMPLE IRAs are made on a pre-tax basis, making savings easier to do.
For 2017, the salary reduction limits are:
- 401(k)s: $18,000 ($24,000 if at least 50 years old by the end of 2017)
- SIMPLE IRAs: $12,500 ($15,500 if at least 50 years old by the end of 2017)
These contributions save income taxes, but are not exempt from FICA. Review the rules for these arrangements in IRS Publication 560.
If you don’t pay for your employees’ health insurance, you can enable them to pay for their policies on a pre-tax basis using a premium-only cafeteria plan. This plan allows them to choose between additional compensation (which is taxable to them if they take this option) or the health coverage (which is tax free).
You can also help them pay their out-of-pocket medical costs through a flexible spending account. The most they can put into their account in 2017 is $2,600. This amount could be increased for 2018 as a result of inflation (we won’t know until later this year). For this pre-tax arrangement, employees need to understand that their contributions are made on a use-it-or-lose-it basis (the plan may allow for a limited grace period or a small carryover).
Dependent care costs
You can also set up a flexible spending account to enable employees to cover their child care costs. The annual limit on their salary reduction contributions to the plan: $5,000 (no adjustments for inflation).
While there are employment tax savings for offering these options to employees, there are administrative costs for setting up and, in some cases, monitoring the plan. Talk with your tax advisor and a benefits expert to determine whether any or all of these plans make sense for your company.