How to Calculate Imputed Tax

A regular paycheck isn't the only reason employees come to work every day. Additional benefits, such as having a great boss and group insurance, are valuable to employees as well. Some of these are almost as valuable as cash, especially where the IRS is concerned.

Imputed income applies a cash value to other types of compensation – fringe benefits – that go beyond weekly pay. Most forms of compensation have a taxable value, although being a great boss is still tax-free.

Imputed Vs. Exempt Benefits

When fringe benefits qualify as imputed income, the employer is tasked with adding this additional income to the employee's gross wages for tax purposes. Unless the IRS excludes a fringe benefit, it should be included in gross income. Some exclusions include:

  • Employee education assistance up to $5,250 in 2019;
  • Achievement awards up to $1,600 for qualified awards and $400 for nonqualified awards;
  • Group term life insurance up to $50,000;
  • Dependent care assistance up to the tax-free amount;
  • Employee-provided cellphones used primarily for work;
  • Adoption assistance up to the tax-free amount;
  • Parking costs up to $265;
  • Retirement planning services; and
  • Employee discounts up to the tax-free amount.

Fringe benefits that aren't excluded include stocks, personal use of employer vehicles, gym memberships and non-deductible moving expense reimbursements.

IRS Rules for Employee Discounts

Employee discounts on items your company sells are normally excluded from income, provided the discounts aren't overly steep. If you give an employee anything that you don't sell to customers, such as stocks, cars or other property, it must be included as income.

Employee discounts can usually be excluded from an employee's wages for:

  • Services: 20% of the price charged to customers; and
  • Merchandise or other property: your gross profit percentage multiplied by the price you charge customers.

To calculate whether an employee merchandise discount can be excluded, the IRS recommends using the gross profit margin you made on all property offered to customers – including employees – based on the previous tax year.

Imputed Income Calculator for Employee Discounts

Suppose you gave an employee an item for $40 from your store that you usually sell to customers for $100. To determine whether this should be included or excluded as income, you need to know your gross margin percentage.

To calculate gross margin, subtract the total cost of the item from the total sales price and divide this number by the total sales price. If this is your first year in business, you can estimate your gross margin based on its markup or by using an industry average margin.

For example, if you make a 40% gross margin and you normally charge $100 for an item, the exclusion amount is $40, so you would not have to consider this item as income. However, if you sold it to the employee for only $30, then you would have to add the difference, $10, to the employee's gross income for tax purposes.

Reporting Imputed Income for Tax Purposes

It's the employer's responsibility to report imputed income on the employee's W-2 form. Each type of benefit requires a specific code in Box 12.

Before deciding whether a benefit should be included, refer to the IRS Employer's Tax Guide to Fringe Benefits for the current tax year, talk to your accountant or – if needed – contact the IRS.

In most cases, you need to withhold Social Security and Medicare taxes. However, you are not usually required to withhold income tax. Despite this, you may withhold income tax at your discretion. In some cases, the employee may prefer that you withhold it, so she doesn't have to pay additional tax when she submits her tax return.