A Simple Guide to Deducting Employee Benefits

  • Accracy
  • 26th Nov, 2023

Ever had a job with great benefits? You weren't the only one benefitting from them.

A Simple Guide to Deducting Employee Benefits
Tax Tips

Employee pay

Whether you've hired a single part-time assistant or a dozen full-time software developers, the cost of employee pay is deductible.

Keep in mind that any business expense you deduct must be both "ordinary and necessary," and that any wage and salary costs you claim must be "reasonable" for the role the employee is performing. The IRS's test for reasonableness involves comparing your employee's pay to what a similar business would pay for the same services.

Vacation pay, sick time, and disability benefits

You can deduct these costs as long as the employee doesn't also get compensated for the same loss of pay from insurance or another source.

HSA employer contribution

HSA stands for health savings account. The cost of personal health insurance, long-term care insurance, and critical illness insurance for employees is usually deductible, if the plans are qualified by the IRS.

Contributions you make to an employee group health plan are also deductible, as long as you (the business owner) don't deduct for your own premiums, which means you'll need to separate those costs in your books. If your business is a C corporation, however, you can deduct your own premiums.

Contributions made to the HSA of an eligible employee are also deductible. (Keep in mind that the limits for total combined employer and employee contributions to an HSA change every year.)

Section 125 or "cafeteria" plans

Cafeteria plans are like a bundle deal for benefits. They're tax-shielded, and they usually include some combination of health benefits, adoption assistance, dependent care assistance and/or health savings accounts (HSAs).

Contributions you make to an employee's cafeteria plan are deductible, provided they satisfy the conditions laid out in section 125 of the Internal Revenue Code.

Check out the IRS's guide to section 125 plans for more information, and check with a tax professional to make sure your plan qualifies.

Employee assistance programs (EAPs)

Employee assistance programs (EAPs) are fully deductible. This includes counseling programs for family issues, substance abuse, and other issues that negatively affects your employees' ability to work.

Life insurance coverage

Contributions you make to an employee's life insurance coverage are deductible as long as you don't "directly or indirectly benefit" from that policy. For more information on what that means, see section 1.264-1 of the Code of Federal Regulations or meet with a tax professional.

Education expenses

You can deduct education expenses as long as they maintain or improve an employee's work-related skills, and as long as they're part of a qualified educational assistance program.

These expenses usually can't include the cost of tools or supplies (other than textbooks), for example, or the cost of lodging and meals.

Check out our guide to deducting education, classes and workshops for more information, and refer to page 10 of this IRS guide for a full list of which education expenses qualify.

Retirement plans

You can deduct the total amount that you contribute to the employee's retirement plan.

"De minimis" fringe benefits

"Fringe benefits" are any non-wage compensation you give your employees, and "de minimis" is just a fancy Latin term that the IRS uses to refer to costs that are too small to account for.

How small? The IRS hasn't established an exact dollar amount, but some have argued that costs below $25 are in the ballpark.

Many de minimis fringe benefits are deductible, as long as they're "occasional or unusual in frequency."

Some IRS examples of "de minimis" benefits:

  • Occasional employee use of photocopier
  • Occasional snacks, coffee, doughnuts, etc.
  • Occasional tickets for entertainment events
  • Holiday gifts
  • Occasional meal money or transportation expense for working overtime
  • Flowers, fruit, books, etc., provided under special circumstances

For more information, see page nine of the IRS guide to de minimis fringe benefits.

Meals and lodging

You can usually deduct some of the cost of providing meals and lodging to your employees. Most meals are 50% deductible, for example, but meals that you include in an employee's wages, or meals that qualify as a "de minimis" fringe benefit are 100% deductible.

The IRS also provides a full rundown of which meals and lodging are deductible in this guide.

Gifts and gift certificates

Gifts to employees can generally be deducted by your business if the gifts are of "nominal" value (read: small).

But even if you keep them small, there are exceptions. "Cash equivalent items" like gift certificates, for example, are considered a part of an employee's income, so they're usually not deductible.

Bonuses and awards

You can deduct an employee bonus as long as you can show the IRS that the bonus was directly tied to specific work that the employee did.

Up to a maximum of $1,600 per employee, you can deduct two kinds of employee awards: length of service awards, and safety achievement awards. See this IRS guide for a full breakdown of the rules around awards.

Claiming these expenses

How you claim these business expenses will depend on your specific business structure.

Sole proprietorships and single-member LLCs use the "Expenses" section of Schedule C.

Partnerships and multi-member LLCs use the "Deductions" section of Form 1065.

Corporations use the "Deductions" section of Form 1120 or Form 1120S (for S Corporations).

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