It's a deductible expense to them whether or not it is tax free to you. The only difference is that by including it in your W-2, they would have to pay an additional 7.65% employment tax. Of course, the income tax you would have to pay reduces the purchasing power of the supplement.
I will try to find some documents for them that the supplement must be taxed. If they don't, they're the ones who get fined, not you.
