If you are a small business owner with employees, chances are you're providing them with some employee benefits, whether or not you're aware of it. When you give your employees discounts on the services you sell or the products you produce, or when you give them paid holidays or vacation time, you are providing a benefit - a form of compensation for their services.

You can generally deduct the cost of providing employee compensation and benefits as a business expense.

Did You Know? Employers continue to be generous with employee benefits despite the rising costs of doing so. According to the U.S. Chamber of Commerce's annual survey of its members, employers provided an average of $20,158 in benefits per employee in 2005, compared to $18,358 in 2004. Employee benefit costs represented 40.2 percent of payroll among the nearly 720 companies responding, according to the study. Medical benefits were the most expensive, accounting for 11.9 percent of payroll. The most common benefits offered by employers continue to include health insurance, paid holidays and vacation, and retirement plan benefits.

Note that the issue here is different from the issue of whether the payment or benefit is taxable to the employee for purposes of computing payroll taxes. Some types of benefits are not taxable for payroll tax purposes; that is, they are not taxable to the employee for FICA or income tax withholding purposes, and they are not taxable to you for FICA or FUTA tax purposes. Common examples of this are health insurance, qualified retirement plan contributions, and group-term life insurance up to $50,000. However, the cost of providing these benefits is still deductible by the employer.

Fringe benefits that are not specifically excluded from employees' income under the tax laws must be included in the employee's taxable income, at their value. This is also true when the benefits are of a type that would be excludable if they met all the federal requirements, but for some reason your plan does not meet the requirements. For instance, some types of plans are not permitted to discriminate in favor of highly compensated employees such as the business owners. If the plans do discriminate, the value of the benefits will generally be taxable compensation to the highly compensated employees who receive them.

However, the cost of the benefit is still deductible to you. And in some cases, the cost to the employer and the value to the employee are not the same, at least in the eyes of the IRS.

For example, if you let your sales representatives use a company car, the value of this noncash fringe benefit must be included in the sales representative's wages as part of his or her compensation. You will not be able to deduct the value of this fringe benefit as a wage expense. However, you can deduct your costs of providing the cars, including the depreciation expense.

Some special rules and limits apply to some of the most common types of payments to employees:

• awards and bonuses
• loans or advances
• vacation pay and unpaid salaries
• meals and lodging
• life and health insurance
• deductible medical savings accounts (MSAs)
• retirement plans