How to Calculate Imputed Income for Payroll

Imputed income is the value of non-cash benefits or services provided to an employee that are subject to taxation. While not a direct cash payment, the Internal Revenue Service (IRS) considers these benefits to have a monetary value that constitutes a form of compensation. The purpose of tracking and taxing this income is to ensure all employee earnings are treated equitably for tax purposes, preventing significant compensation from being provided as non-cash perks to avoid tax liabilities.

Common Types of Imputed Income

A frequent source of imputed income is group-term life insurance coverage that exceeds $50,000. Another common example is the personal use of a company-provided vehicle. When an employee uses a company car for commuting or other personal travel, the value of that personal use must be calculated and included in their taxable wages.

Other benefits, such as employer-provided gym memberships, are also treated as imputed income. Educational assistance programs that provide benefits exceeding the annual exclusion amount of $5,250 per year result in taxable income for the excess amount. Through the end of 2025, this exclusion also allows for tax-free payments made by an employer toward an employee’s qualified student loans.

What Is Not Imputed Income

Not all fringe benefits are subject to taxation. The IRS allows for an exception for “de minimis” benefits, which are items provided by an employer that have such a small value that accounting for them is unreasonable or administratively impractical. Examples include occasional personal use of a company copy machine, coffee and donuts provided in a breakroom, or small, infrequent gifts like a holiday turkey. These items are non-taxable and do not need to be added to an employee’s income.

Information Needed for Calculation

For group-term life insurance, you need the employee’s age as of the end of the calendar year and the total amount of life insurance coverage. The IRS provides the specific rates for the calculation in Publication 15-B, Employer’s Tax Guide to Fringe Benefits. This publication contains “Table 2-2. Cost Per $1,000 of Protection for 1 Month,” which lists the cost based on five-year age brackets.

For the personal use of a company vehicle, you need the vehicle’s Fair Market Value (FMV) when it was first made available to the employee. A detailed log of miles driven is also required, separating total miles for the year into personal and business miles.

For other benefits like a gym membership, you need the Fair Market Value (FMV) of that benefit. The FMV is the price an individual would have to pay to purchase the same benefit from a third party, not the employer’s cost to provide it.

Step-by-Step Calculation Methods

Calculating for Group-Term Life Insurance

First, determine the amount of coverage subject to tax by subtracting the $50,000 exclusion from the total life insurance coverage. For instance, if an employee has $150,000 in coverage, the taxable portion is $100,000. Next, divide this taxable amount by $1,000 to determine the number of insurance units, which is 100 in this example.

Using the employee’s age at year-end, find the corresponding rate in the IRS’s “Cost Per $1,000” table within Publication 15-B. If a 42-year-old employee’s rate is $0.10 per $1,000 of coverage, you would multiply this rate by the 100 units of insurance for a monthly imputed income of $10. This monthly figure is multiplied by 12 for the annual amount of $120.

Calculating for Personal Use of a Company Vehicle

Two methods exist for calculating the value of personal vehicle use: the annual lease value method and the cents-per-mile method. The Annual Lease Value (ALV) method requires determining the vehicle’s ALV from an IRS table in Publication 15-B, based on the car’s Fair Market Value. This ALV is then multiplied by the percentage of personal use, calculated by dividing personal miles by total miles driven.

The cents-per-mile method is available for vehicles that are not considered luxury automobiles. To use it, multiply the total personal miles driven during the year by the standard cents-per-mile rate set by the IRS. For example, if an employee drove 5,000 personal miles and the rate was 70 cents per mile, the imputed income would be $3,500.

Calculating for Other Benefits

For other fringe benefits, such as gym memberships or educational assistance above the tax-free limit, the imputed income is the Fair Market Value (FMV) of the benefit. If an employer pays $600 for an employee’s annual gym membership, and that is the price anyone would pay for it, the full $600 is added to taxable wages. Any amount the employee contributed toward the cost is subtracted from the FMV to arrive at the final imputed income amount.

Reporting and Tax Withholding

Once calculated, imputed income must be properly reported and subjected to tax withholding. The calculated value is added to the employee’s regular earnings to determine the total taxable wages.

The total value of the imputed income is reported on the employee’s Form W-2. The amount is included in the totals shown in Box 1 (Wages, tips, other compensation), Box 3 (Social Security wages), and Box 5 (Medicare wages). For example, the value of group-term life insurance coverage over $50,000 must also be reported separately in Box 12 using Code C.

Imputed income is subject to FICA taxes (Social Security and Medicare), and employers are responsible for withholding the employee’s share and paying the employer’s share. While federal income tax withholding is not always required, the value is still part of the employee’s gross income. Employers may choose to withhold income tax on these benefits or allow the employee to account for it on their personal return.