Imputed income is subject to federal income tax, Social Security tax, and Medicare tax just like regular wages. Although employees do not receive actual cash, the IRS requires them to pay taxes on the fair market value of the benefits received. This additional income is reflected on the W-2 form in Box 1 (wages, tips, and other compensation) and potentially other boxes depending on the type of benefit.
Employees may notice an increase in tax withholdings or a higher tax liability when they file their annual returns. For businesses, it’s important to inform employees about these tax implications ahead of time to avoid confusion or dissatisfaction. Transparent communication, supported by a compliant payroll system or EOR like 1EOR, can help educate staff and maintain employee trust. Professional handling of imputed income also helps reduce errors and supports long-term organizational integrity.