Accounting and Withholding Taxes for Fringe, Wellness, and Lifestyle Spending Account Benefits
By Acru Solutions in collaboration with Joon
An increasing number of our clients have been inquiring about fringe, wellness, and lifestyle spending account benefits. In this resource, we’ll cover what these benefits are, how to account for them from a journal entry perspective, and how to properly withhold taxes.
Disclaimer: While we are tax and accounting professionals, you should not consider any of the following as formal tax advice, but should instead consult your own advisors. That being said, we’d be happy to speak directly with you in a more formal capacity. To get in touch, contact kevin@acru.solutions.
Defining fringe, wellness, and lifestyle spending account benefits
The terms “wellness benefits” and “lifestyle spending accounts” have no formal or US government-recognized definition (you won’t find them in the tax code) and are often but not always used interchangeably by employers to describe types of benefits offered to their workforces. Often these programs include an allowance or stipend that can be used toward improving an employee’s physical, mental, or professional wellbeing.
Because these programs are not recognized or incentivized by the government, they do not have the tax advantages (e.g. “using pre-tax dollars”) of more formal benefits programs like HSAs, FSAs, 401(k), etc. That doesn’t mean that they can’t have rules or standards – just that those rules and standards are determined by employers and vendors rather than the IRS. The IRS uses the term “Fringe Benefit” to describe how to handle taxes and accounting for such benefits in Publication 15-B.
To summarize, “wellness benefits” and “lifestyle spending accounts” are flexible terms that fall under the broader purview of “fringe benefits” that do not have tax advantages. Benefits within such programs are either treated as taxable income or non-taxable business expenses with limitations which we’ll cover in the next section.
While tax-advantaged benefits sound great, they often come with a lot of restrictions and compliance. Alternatively, employers may prefer a wellness or lifestyle spending account benefit for two reasons:
They want to offer a benefit that cannot be offered via a regulated program. For example, there is no way to reimburse employees for doggy daycare or for a National Park Pass in a tax-advantaged way.
They do not want to deal with the complexities of administering a regulated program. For example, tax-advantaged programs often require physical receipts and for employees to prefund accounts in advance in order to use funds or receive a reimbursement. Any purchase that would be reimbursable within an HSA or FSA can also be made reimbursable within a wellness benefit or lifestyle spending account, just without the corresponding tax advantages.
Depending on the employer, industry, and labor market, it may make a lot of sense to administer a wellness or lifestyle spending account benefit.
Further reading: Compare the pros and cons of pre-tax vs. taxable benefits
Withholding taxes for benefits
The tax ramifications of an employee’s wellness benefit or lifestyle spending account depend on the purchases they’ve made. Don’t fret – while there’s a lot to understand in this section, the actual process of withholding taxes can take as little as a few minutes of HR administration time per year.
As a general rule, if the purchase would be considered a legitimate business expense, the employee can be reimbursed 100% without any tax consequences. Examples include professional development (e.g. attending a conference) and certain work-from-home expenses (e.g. a company cell phone). Essentially the employee will have used their own funds for a business expense and should have some form of documentation (e.g. a receipt) as proof of the purchase. There are some more nuanced types of business expenses like paid parking and business use of a personal vehicle, but these are less commonly included in wellness benefits and lifestyle spending accounts, so we won’t go deeper on them in this article.
Virtually everything else should be treated as taxable income. The good news is that because the reimbursement is taxable, the IRS does not require documentation like a receipt nor do they care what the employee spent on. If you want to reimburse employees for their Netflix subscription, that’s your prerogative as an employer as long as taxes are withheld as though that reimbursement was income.
Further reading: Examples of taxable vs. non-taxable purchases
If you make these reimbursements manually via payroll, then taxes should be withheld automatically (as though you were giving a spot bonus). If you use a vendor to manage reimbursements, however, then you will need to separately withhold taxes in your payroll system. Your benefits vendor should be able to output a report showing reimbursements per employee segmented by taxability. They may even be able to format the report to fit your payroll system’s requirements for bulk import.
Every payroll system is a little bit different, but virtually all of them will have a way to import what is called “imputed income” or “fringe benefits.” This notifies your payroll system that employees were paid externally and need to have taxes withheld from their next pay stub. For example, here is how to bulk import fringe benefits in Justworks and how to add imputed pay in Gusto. If you don’t see a way to bulk import, contact your account manager – they almost always have a way of doing so if you give them a csv.
The IRS does not care when taxes are withheld so long as they are withheld at some point before January 31 of the following year. Per Publication 15-B:
For employment tax and withholding purposes, you can treat taxable noncash fringe benefits (including personal use of employer-provided highway motor vehicles) as paid on a pay period, quarter, semiannual, annual, or other basis. But the benefits must be treated as paid no less frequently than annually. You don't have to choose the same period for all employees. You can withhold more frequently for some employees than for others.
Modern payroll systems will give you the choice to “gross up” taxes, basically meaning you’ll cover them as the employer so that employees don’t notice any change in their pay stubs. If you don’t plan to gross up taxes, it often makes sense to import imputed pay on at least a quarterly basis so that employees aren’t hit with a large and unexpected tax withholding at the end of the year.
Accounting for benefits
From an accounting perspective, the situation is similarly straightforward depending on what vendor you select to administer benefits. As a finance team, there are two things to account for: the vendor fees and the employee reimbursements.
The vendor fees, or software subscription fees, should be a journal entry like any other HR software application. That part is straightforward.
The reimbursements can be a little trickier depending on whether you’re administering the program manually, using a vendor that makes you pre-fund an accrual, or using a vendor that lets you pay in arrears. Let’s take a look at each:
Administering the program manually either by (i) issuing cards from a bank or expense software or by (ii) having employees submit receipts for reimbursement. While each transaction can simply be associated with the same benefits category, the issue with this approach is that every single transaction sits on your books in the first place. For a number of reasons, many finance teams may not want a record of every single purchase an employee makes as part of a wellness or lifestyle spending program. There can be more complications: if an employee makes a purchase that is later deemed ineligible, they will need to reimburse you, which creates yet another journal entry. Further, administering programs manually comes with the added overhead of managing allowances and handling partial reimbursements.
Benefits vendor that makes you pre-fund an accrual. This approach is a lot less complicated than the former, although it requires you to basically maintain a balance with a third-party that is topped off periodically as employees spend against it with cards or marketplaces. This eliminates the need to have every transaction sitting on your books, but does require manually accounting for an accrual each month.
Benefits vendor that lets you pay in arrears. This approach is the simplest of all since it doesn’t require maintaining a record of every employee transaction or managing a pre-funded accrual. Instead, a lump sum of reimbursements is paid and distributed to employees after eligible purchases have been made with their own personal funds. This can be a single journal entry.
With any of the above approaches, reimbursements can be journal entries within one benefits budget or segmented by class if you want to track benefits spending per department. Most vendors will be able to create a report that associates reimbursements segmented by class if you’ve provided that information with your roster or HRIS sync.
Conclusion
Whenever a new form of compensation gains in popularity, it can feel overwhelming to get up to speed on optimization and compliance. Ultimately, you should feel confident that this is a solvable problem that won’t necessarily add a significant administrative burden. In fact, if you choose the right tax partners and benefits vendors, it may even save you significant time compared to what you’re already doing.
