Law and economics professor examines how to tax fringe benefits most efficiently.
Determining what gets taxed can become incredibly difficult. If your company gives you a $50 gift card, do you have to pay tax on it? What if your company pays for a corporate lunch that you are required to attend? What about free daily lunches or dinners? Should the government tax you for any of these?
In a recent paper, Yehonatan Givati, a law professor at Hebrew University, tackles how to tax fringe benefits optimally so that employers cannot circumvent income taxes through generous fringe benefits but also so that they are not overly dissuaded from providing fringe benefits in the first place.
Givati starts by examining four different alternatives: no taxation, taxation at fair market value, taxation at average value, and taxation based on worth to recipient. Ultimately, Givati concludes that while the ideal solution would be to tax based on worth to the recipient, objectively measuring this is difficult and so he favors taxation at half of the fair market value, which best approximates the ideal.
Givati classified the tax alternatives into two groups: those that would be easy to implement, which includes no taxation and taxation at fair market value, and those difficult to implement, which includex taxation based on worth to recipient and taxation at average value. He calculates, using a hypothetical scenario, how many business dinners to which an employer should, economically, send its employee. Afterwards, Givati compares this ideal number with how many business dinners each of the tax alternatives would result in.
Using this methodology, Givati determines that no taxation would result in overuse of business dinners, while taxation at fair market value would result in the opposite. Givati then determines that taxation based on worth to the recipient would result in the ideal number of dinners, while taxation at average value would result in less than the ideal number.
Although taxing recipients based on the value of a fringe benefit to its recipient might be the best option economically, Givati notes how difficult it would be to implement. Individuals might lie about how much they value the fringe benefits they receive and the Internal Revenue Service would have difficulty determining through other means what this value for these fringe benefits might be. As a result, Givati proposes taxation at half of fair market value, which approximates the impact that taxation based on recipient worth would have but is much easier to calculate objectively.
Beyond recommending taxation at half of market value, Givati also offers three insights about the effects of fringe benefit taxation policy. First, he notes that employees who receive fringe benefits are not theoretically better off than comparable employees who do not, since companies can deduct the cost of these benefits from employees’ salaries. Because these employees are not better off than comparable employees, they would also not be better off compared to other people in society.
Second, Givati notes that tax policy has an inverse effect on the usage of fringe benefits. A tax policy that under-taxes fringe benefits will result in their overuse, and vice versa.
Finally, Givati comments that scholars have traditionally under-realized the impact of fringe benefits taxation policy. Non-taxation leads to a situation where fringe benefits are untaxed, as intended, but where companies compensate their employees using fringe benefits rather than traditional pay, further reducing how much these employees pay in income taxes.
Givati then applies his determinations to Silicon Valley employers’ provision of meals to employees. He notes how there is an overprovision of these meals because they are not currently taxed for employees. He comments that failure to tax at fair market value results in the loss of potentially hundreds of millions in revenue each year, but he also shows how doing so could lead to under-provision of meals.
Fringe benefits are currently taxed at any additional amount over either what the law excludes or what the recipient paid. However, a variety of exceptions exist which complicate how fringe benefits are taxed.
With new developments in the workplace, taxation of fringe benefits has become harder to determine. Companies such as Google are widely known for giving free lunches and dinners to their employees. While companies have traditionally given employees many fringe benefits such as insurance coverage, some have added new ones such as day-care for children or gym memberships.