Offering competitive salaries is important for attracting and retaining talented employees, but compensation is only part of the equation. A well-designed benefits package can add significant value to an employee’s overall compensation — especially when certain benefits receive favorable tax treatment.
With open enrollment approaching for many businesses, now is a good time to review your employee benefits and consider changes for 2027.
The IRS is expected to announce the inflation-adjusted limits for 2027 later this year, so the 2026 figures can serve as a useful starting point for planning. Businesses should also be aware that the One Big Beautiful Bill Act (OBBBA) changed several rules affecting fringe benefits.
Insurance Benefits That May Be Tax-Free
Employers can offer several types of insurance benefits that may be excluded from employees’ taxable income. However, the rules differ depending on the type of coverage.
Health Insurance
Employer contributions toward health insurance coverage are generally excluded from an employee’s taxable wages. This can include coverage provided for an employee’s spouse and dependents.
Employees may also be able to make pretax contributions toward their health insurance through a qualified cafeteria plan. If contributions are not made on a pretax basis, they generally are included in wages, although employees may potentially qualify for an itemized deduction subject to applicable limitations.
Disability Insurance
Employer-paid premiums for disability insurance generally aren’t taxable to employees when the coverage is provided under a qualifying plan.
The treatment of employee-paid premiums can be different. Generally, employees can’t deduct premiums they pay themselves or exclude them from income, unless the contributions are made on a pretax basis through a cafeteria plan.
It’s also important to consider what happens if an employee later receives disability benefits. The taxability of those benefits can depend on who paid the premiums and whether the premiums were paid with pretax or after-tax dollars.
For this reason, employers should consider the potential tax consequences when deciding how disability insurance premiums will be divided between the business and its employees.
Long-Term Care Insurance
Employer-provided long-term care insurance can generally be excluded from an employee’s wages.
However, different rules apply when long-term care coverage is provided through a flexible spending arrangement or a similar benefit arrangement. In those circumstances, the coverage generally can’t be excluded from an employee’s wages for federal income tax purposes.
Even so, employer contributions generally aren’t subject to Social Security, Medicare or federal unemployment taxes.
Group-Term Life Insurance
Employees generally can exclude the cost of up to $50,000 of employer-provided group-term life insurance coverage from their taxable income.
When coverage exceeds $50,000, the cost of the additional coverage is generally taxable to the employee. The taxable amount is calculated using IRS rates and is reduced by any amount the employee pays toward the coverage.
Other Tax-Advantaged Employee Benefits
Insurance isn’t the only way businesses can provide tax-favored compensation. Several other employee benefits may also offer favorable tax treatment.
Dependent Care Assistance
The OBBBA increased the annual exclusion for employer-provided dependent care assistance beginning in 2026.
The maximum exclusion increased from $5,000 to $7,500 per year, or $3,750 for employees who are married and file separately.
The exclusion remains subject to other requirements and limitations, including rules involving the earned income of the employee and their spouse and the requirements that apply to dependent care assistance programs.
Adoption Assistance
Employers can provide tax-favored adoption assistance through a qualified adoption assistance program, subject to applicable rules and limits.
For 2026, the maximum amount that can be excluded from an employee’s income is $17,670 per child. The exclusion begins to phase out when modified adjusted gross income reaches $265,080 and is completely phased out at $305,080.
Although qualifying adoption assistance generally can be excluded from federal income tax, employer-provided adoption benefits generally remain subject to Social Security, Medicare and federal unemployment taxes.
The exclusion amount and applicable income thresholds are adjusted periodically for inflation.
Educational Assistance
Employers can provide up to $5,250 in tax-free educational assistance per employee each year under a qualifying written educational assistance program.
The OBBBA made this exclusion permanent and provides for the $5,250 limit to be adjusted for inflation for tax years beginning after 2026.
Eligible educational assistance can cover qualifying education expenses, including certain graduate-level education. It can also be used to pay principal or interest on an employee’s qualified education loans.
Transportation Benefits
Qualified transportation benefits can also be provided tax-free within federal limits.
For 2026, employees can generally exclude up to $340 per month for qualified transportation provided through a commuter highway vehicle or transit passes. The monthly exclusion for qualified parking is also $340.
These limits are adjusted annually for inflation.
One important consideration for employers is that businesses generally can’t deduct qualified transportation fringe benefits provided to employees.
De Minimis Fringe Benefits
Certain small or occasional benefits can generally be provided to employees without creating taxable income.
These are known as de minimis fringe benefits. They generally apply when the value of a benefit is so small, and the benefit is provided so infrequently, that keeping track of the benefit would be unreasonable or administratively impractical.
Examples can include occasional personal use of an employer’s copier, certain entertainment or sporting event tickets, noncash holiday or birthday gifts and certain meals.
Cash and cash-equivalent benefits generally don’t qualify. For example, gift cards and gift certificates typically are treated as taxable compensation rather than de minimis fringe benefits.
No-Additional-Cost Services
Employers may also be able to provide certain services to employees tax-free when providing the service doesn’t create a substantial additional cost for the business.
This benefit generally applies to excess-capacity services that an employer normally provides to customers in the same line of business in which the employee works.
For example, a hotel may allow an employee to stay in an otherwise vacant room, while an airline may allow an employee to use a seat that would otherwise remain empty.
Additional eligibility and nondiscrimination requirements may apply, so businesses should review the rules carefully before treating these benefits as tax-free.
OBBBA Also Eliminated Some Fringe Benefit Tax Breaks
Not all of the changes under the OBBBA were favorable to employers and employees.
The law permanently eliminated the federal exclusion for qualified bicycle commuting reimbursements. It also permanently eliminated the exclusion for qualified moving expense reimbursements for most employees.
There are exceptions for certain members of the U.S. Armed Forces and the intelligence community.
Businesses should therefore review older benefit programs to determine whether they still receive the same tax treatment under the current rules.
Watch Out for Nondiscrimination Rules
A fringe benefit that is tax-free for most employees may not necessarily receive the same tax treatment for highly compensated employees or business owners.
Some fringe-benefit exclusions are subject to nondiscrimination requirements. In addition, special rules apply to certain types of business owners, including partners and shareholders who own more than 2% of an S corporation.
Before introducing or changing a benefit, employers should determine whether additional restrictions apply to their particular business and employee group.
Make the Most of Your Employee Benefits Package
Fringe benefits can significantly increase the overall value of an employee’s compensation package. When structured properly, tax-favored benefits may improve employees’ after-tax compensation while helping businesses make better use of their compensation budgets.
As you prepare for 2027 open enrollment, review your current benefits and consider whether there are opportunities to improve your package.
Because tax rules and annual limits can change, businesses should review their plans with a tax professional before making significant changes. Professional guidance can help ensure that benefits are structured correctly and that both the business and its employees receive the intended tax treatment.
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