Imputed income is a little bit of a mystery. It’s not overly common. However, when you encounter it, you can be left with an uneasy feeling.
Let’s start by covering what it is. Then we’ll go over why it happens and how to prevent it.
What is imputed income?
The technical definition is: when the value of a service or benefit, provided by employers to employees, must be treated as income.
Ok, so what does that even mean?
- Your employer provided a benefit (aka: allowed you to set aside funds pre-tax).
- When you enrolled in the benefit, you agreed to follow the rules of the account and only use the funds for eligible expenses under the plan.
- When the use of funds was reviewed, expenses were either not able to be verified or were not used as anticipated.
- The funds must then be imputed (or treated as income) and subject to payroll taxes.
Why it happens
FSAs and Imputed Income
With Flexible Spending Accounts (FSAs), imputed income is the last resort when receipts requests (or supporting documentation) are not provided. For a refresher on receipt requests, check out the following resources:
- Why Receipt Requests (Downloadable FAQs)
- What is substantiation and why is it required?
- Best practices to avoid receipt requests
In short, a benefits card is used for an expense that may or may not be eligible. If the expense cannot be auto-adjudicated, it must be manually verified as eligible. This results in a receipt request being sent to an employee.
When the requested documentation is not provided within a required time period, the value of the expense is reported and may be treated as imputed income.
Remaining CBP funds may be subject to Imputed Income
With a Commuter Benefit Plan (CBP), imputed income only occurs when an employee stops participating in the plan and has remaining funds.
Let’s take a look at a specific scenario:
Jane ends her employment with ZZZ Corp. on February 20. She has $100 remaining in her commuter benefit account.
1. Jane has until the end of the month (February 28) to use the funds tax-free. Any funds not used within that time are reported and may be treated as imputed income, meaning those funds are now taxable income.
2. After termination, Jane has until the end of the following month (March 31) to use all the funds.
Now that you know what leads to imputed income, let’s go over how to prevent it from happening in the future.
How to prevent it from happening in the future
When it comes to your CBP, avoiding imputed income is quite simple. Use the funds within the permitted time period. If you use up all of your funds within that time, it will prevent the funds from becoming imputed.
In terms of an FSA, it’s easy to avoid imputed income by taking two steps:
1) Save all receipts
2) Provide substantiation as soon as you receive a receipt request
While the above sounds nice in theory, we know it doesn’t always go that way in practice. To help you put the steps into action, we’ve put together a cheat sheet on managing receipt requests (and avoiding imputed income).
Download the one page guide here: