Employer-provided stipends are often seen as an appealing and valuable part of compensation packages. Whether in the form of a wellness stipend, travel allowance, or even education reimbursements, stipends can be designed to cover specific expenses that align with employee well-being, personal development, or work-related costs. While these perks may seem like a clear advantage, there are instances where it may actually be more beneficial for an employee to decline a stipend, particularly for tax reasons (learn more about the taxability of stipends).
In this article, we’ll explore why and when it might make sense to refuse an employer-offered stipend, diving into the tax implications and potential financial drawbacks that employees should consider.
Understanding the Basics of Employer Stipends
Employer stipends are fixed sums of money that companies provide to employees for specific expenses. Unlike salaries or bonuses, stipends are often tied to particular activities or costs. For example, many companies provide wellness stipends to cover gym memberships, health programs, or even mental health resources. Similarly, travel stipends might cover commuting costs, while education stipends may assist with tuition for job-related courses or certifications.
However, many stipends, especially those not directly related to work expenses, are treated as taxable income by the Internal Revenue Service (IRS). This means that when an employee receives a stipend, it is added to their total taxable income for the year, and the employee is responsible for paying taxes on it. This is where the decision to accept or refuse the stipend can become more complicated.
When Accepting a Stipend May Lead to Higher Taxes
The key reason why an employee might choose to refuse an employer-offered stipend is the potential impact on their taxable income. When a stipend is considered taxable, it increases the employee’s total income for the year, potentially bumping them into a higher tax bracket or subjecting them to additional taxes they might otherwise avoid. Here are several scenarios where refusing a stipend could be beneficial for tax purposes:
1. Risk of Being Pushed into a Higher Tax Bracket
One of the most common tax concerns for employees is being pushed into a higher tax bracket. In the U.S., the income tax system is progressive, meaning that as you earn more, your tax rate increases. Each taxpayer falls into one of several tax brackets, and earning more income can push you into a higher bracket, where a larger percentage of your income is taxed.
For example, if you are close to the threshold of moving into a higher tax bracket, receiving a taxable stipend might push your income above that threshold. As a result, a portion of your income would be taxed at a higher rate, potentially diminishing the financial benefit of the stipend itself. In such cases, it may make sense to refuse the stipend to avoid the higher taxes that come with moving into the next bracket.
2. Additional Payroll Taxes
Stipends that are treated as taxable income are also subject to payroll taxes, including Social Security and Medicare taxes. While these taxes are generally smaller compared to federal income tax, they can still add up. If the stipend amount is relatively small but pushes your total income over a certain threshold, you could be faced with additional payroll taxes that outweigh the benefit of accepting the stipend.
Employees who are at or near the Social Security wage base limit, for example, may find themselves paying extra taxes on stipends that could otherwise be avoided by declining the offer.
3. Impact on Tax Credits and Deductions
Accepting a stipend that increases your taxable income may also affect your eligibility for certain tax credits or deductions. Many tax credits, such as the Earned Income Tax Credit (EITC), are income-dependent, meaning that as your income rises, the amount of credit you can claim decreases. For lower to middle-income employees, accepting a stipend could inadvertently reduce their eligibility for these credits, effectively negating the financial benefit of the stipend.
Additionally, some deductions and benefits phase out as income increases. For instance, deductions related to student loan interest or certain education credits are phased out for taxpayers who earn more than a specific income level. If receiving a stipend pushes you over that threshold, you could lose access to these deductions, potentially making it financially disadvantageous to accept the stipend.
4. State and Local Tax Implications
In addition to federal taxes, employees should also consider the potential impact of stipends on state and local taxes. Some states have their own progressive tax systems, and an increase in taxable income due to stipends can have similar effects as at the federal level, pushing employees into higher tax brackets or reducing eligibility for state-specific credits and deductions.
For example, in states with high income tax rates such as California or New York, accepting a stipend may result in a significant increase in state taxes. In these states, the combined impact of federal, state, and local taxes on the stipend might outweigh the benefits of the additional income.
5. Increased Adjusted Gross Income (AGI) and the Affordable Care Act (ACA)
Another important consideration is how accepting a stipend can affect your **Adjusted Gross Income (AGI)**. AGI is a key figure in determining eligibility for a variety of government benefits, including subsidies for health insurance under the Affordable Care Act (ACA). If accepting a stipend increases your AGI beyond certain thresholds, you could lose eligibility for ACA subsidies, resulting in higher healthcare costs.
For employees who rely on ACA subsidies to afford health insurance, accepting a taxable stipend could lead to a loss of these subsidies, making healthcare significantly more expensive. In such cases, it may be in the employee’s best interest to refuse the stipend in order to preserve their ACA subsidy.
When Refusing a Stipend Is a Strategic Tax Decision
While stipends can provide valuable financial assistance for specific purposes, employees should carefully evaluate the tax implications before accepting them. Here are some key factors to consider:
- Current tax bracket: Assess whether accepting the stipend will push you into a higher tax bracket, resulting in more of your income being taxed at a higher rate.
- Tax credits and deductions: Determine if accepting the stipend will reduce your eligibility for valuable tax credits or deductions, such as education credits or the EITC.
- Payroll taxes: Consider how much of the stipend will be subject to additional payroll taxes.
- State and local taxes: Evaluate the impact of the stipend on your state and local tax obligations, especially if you live in a state with high tax rates.
- Impact on benefits: Understand how accepting the stipend may affect your eligibility for ACA subsidies or other government benefits.
By taking these factors into account, you can make an informed decision about whether accepting an employer-provided stipend will be financially beneficial in the long run. In some cases, it might be smarter to decline the stipend to avoid a higher tax burden and maintain eligibility for other important financial benefits.