Group-Term Life Insurance
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Total Amount of Coverage
IRC section 79 provides an exclusion for the first $50,000 of group-term life insurance coverage provided under a policy carried directly or indirectly by an employer. There are no tax consequences if the total amount of such policies does not exceed $50,000. The imputed cost of coverage in excess of $50,000 must be included in income, using the IRS Premium Table, and are subject to social security and Medicare taxes.
Carried Directly or Indirectly by the Employer
A taxable fringe benefit arises if coverage exceeds $50,000 and the policy is considered carried directly or indirectly by the employer. A policy is considered carried directly or indirectly by the employer if:
- The employer pays any cost of the life insurance, or
- The employer arranges for the premium payments and the premiums paid by at least one employee subsidize those paid by at least one other employee (the “straddle” rule).
The determination of whether the premium charges straddle the costs is based on the IRS Premium Table rates, not the actual cost. You can view the Premium Table in the group-term life insurance discussion in Publication 15-B.
Because the employer is affecting the premium cost through its subsidizing and/or redistributing role, there is a benefit to employees. This benefit is taxable even if the employees are paying the full cost they are charged. You must calculate the taxable portion of the premiums for coverage that exceeds $50,000.
Not Carried Directly or Indirectly by the Employer
A policy that is not considered carried directly or indirectly by the employer has no tax consequences to the employee. Because the employees are paying the cost and the employer is not redistributing the cost of the premiums through an insurance system, the employer has no reporting requirements.
Example 1 – All employees for Employer X are in the 40 to 44 year age group. According to the IRS Premium Table, the cost per thousand is .10. The employer pays the full cost of the insurance. If at least one employee is charged more than .10 per thousand of coverage, and at least one is charged less than .10, the coverage is considered carried by the employer. Therefore, each employee is subject to social security and Medicare tax on the cost of coverage over $50,000.
Example 2 – The facts are the same as Example 1, except all employees are charged the same rate, which is set by the third-party insurer. The employer pays nothing toward the cost. Therefore there is no taxable income to the employees. It does not matter what the rate is, as the employer does not subsidize the cost or redistribute it between employees.
Coverage Provided by More Than One Insurer
Generally, if there is more than one policy from the same insurer providing coverage to employees, a combined test is used to determine whether it is carried directly or indirectly by the employer. However, the Regulations provide exceptions that allow the policies to be tested separately if the costs and coverage can be clearly allocated between the two policies. See Regulation 1.79 for more information.
If coverage is provided by more than one insurer, each policy must be tested separately to determine whether it is carried directly or indirectly by the employer.
Coverage for Spouse and Dependents
The cost of employer-provided group-term life insurance on the life of an employee’s spouse or dependent, paid by the employer, is not taxable to the employee if the face amount of the coverage does not exceed $2,000. This coverage is excluded as a de minimis fringe benefit.
Whether a benefit provided is considered de minimis depends on all the facts and circumstances. In some cases, an amount greater than $2,000 of coverage could be considered a de minimis benefit. See Notice 89-110 for more information.
If part of the coverage for a spouse or dependents is taxable, the same Premium Table is used as for the employee. The entire amount is taxable, not just the amount that exceeds $2,000.
Example 3 – A 47-year old employee receives $40,000 of coverage per year under a policy carried directly or indirectly by her employer. She is also entitled to $100,000 of optional insurance at her own expense. This amount is also considered carried by the employer. The cost of $10,000 of this amount is excludable; the cost of the remaining $90,000 is included in income. If the optional policy were not considered carried by the employer, none of the $100,000 coverage would be included in income.
Group Term Life Insurance Over $50,000: A Planning Opportunity for Executives
As you may be aware, only the first $50,000 of employer provided group-term life insurance is excludable from an employee’s taxable income. The Internal Revenue Code Section 79 provides for the $50,000 exclusion for policies that are carried directly or indirectly by the employer. As long as the total amount of the group-term life insurance does not exceed $50,000 it is not a taxable event. Once the amount does exceed the threshold amount, then it is subject to income, social security and Medicare taxes.
IRS Premium Rates
Coverage exceeding $50,000 is taxed based on arbitrary “costs” assigned by the Internal Revenue Service (“IRS”). The determination of these costs are based on the IRS Premium Rate Tables found in Publication 15-B. Generally, these costs bear no relationship to the premiums an employee would pay if he were to purchase the coverage outside his employer’s plan. Many employers provide group-term life insurance to employees equal to a percentage of salary (e.g., 1ВЅ times salary). This may result in significant taxable income to highly paid employees and executives.
Option Opt of Coverage
Accordingly, these employees may prefer to obtain insurance coverage in excess of $50,000 outside of their employer’s plan. In order to accommodate this desire, the IRS permitted, in private letter rulings, arrangements in which employers give highly paid employees the option to elect or decline all or a portion of their coverage in excess of $50,000 annually; thus, permitting employees to reduce the taxable cost of life insurance coverage over $50,000.
“Carried Directly or Indirectly”
Be aware that the IRS considers a policy to be carried directly or indirectly if the employer pays any cost of the life insurance or arranges for the premium payments and the premiums paid by at least one employee subsidize those paid by at least one other employee. So, a highly compensated employee who has more than $50,000 coverage on a plan that is considered “carried directly or indirectly” would be subject to taxable income on the portion of the premiums that exceed the limit. This is true, even if the employee is paying the full cost they are charged, because the IRS reasons that the amount of the premiums are lower because of the bargaining power of the employer, thereby making a benefit to the employee. [See Employer’s Tax Guide to Fringe Benefits, IRS publication 15-B.]
A plan is not considered “carried” by the employer if the employees are paying for the cost of coverage and the employer is not redistributing the cost of the premiums. Such a system results in no tax consequences. [See 26 CFR 1.79-0.]
Separate Determinations per Policy
The IRS also allows there to be more than one policy offered to employees. If there is more than one, a combined test is used to determine whether the policies are considered “carried” or not. However, Regulation 1.79 provides for the policies to be tested separately, such that an employer could offer a “carried” plan and a non-carried plan. This works only if there is no cross-subsidation between the plans.
On October 16, 2015, the IRS issued a private letter (PR: 201542003) that allows for optional life insurance coverage offered to employees not to be deemed “carried” by the employer. This ruling was based on the facts that the life insurance premiums were paid for with after-tax dollars and the rates did not straddle the rates found in Table 1 of Publication 15-B and that the policy was entirely separate from other benefits offered. This determination would allow highly paid employees to obtain life insurance in amounts greater than $50,000 and not be subject to taxes on the premiums.
Bear in mind that private letter rulings from the IRS, while instructive, are only valid for the taxpayer requesting the determination. However, it appears that an employer could offer an optional group-term life insurance plan to meet the needs of highly paid employees that would not be taxable if:
- The life insurance coverage provided under the plan is a uniform percentage of salary;
- The election is available to all employees within the group, not just a select group of employees;
- No additional compensation is paid to an employee electing to reduce coverage;
- The basic plan and the optional plan are entirely separate with no premium loading allocated between the policies;
- The optional plan was paid for by the employee with after-tax dollars; and
- The premiums were either all at or below Table 1 rates or were all at or above Table 1 rates (not rates on above and below Table 1 rates.)
Familiarize Yourself With Group-term Life Insurance Tax
Fifty-five percent of private industry employees have access to employer-sponsored life insurance, and 98% of those employees enroll in the benefit. As a popular benefit, you might offer group-term life insurance. If you decide to offer it, you need to be familiar with group-term life insurance tax.
What is group-term life insurance?
Group-term life insurance is exactly as it sounds: A type of life insurance offered to a group. Group-term life insurance is a fringe benefit, which is a benefit offered in addition to an employee’s regular wages.
You can offer group-term life insurance to your employees if you meet four requirements:
- The coverage provides a general death benefit that isn’t included in income
- You meet the 10-employee rule (must provide the insurance to at least 10 full-time employees at some time during the year; some exceptions apply)
- The coverage isn’t biased towards certain employees
- You directly or indirectly carry the group-term life insurance policy
An employee who has group-term life insurance coverage chooses beneficiaries. Their beneficiaries receive the benefits of the life insurance plan if the employee dies.
You can also extend group-term life insurance coverage to an employee’s dependents (e.g., spouse and/or children).
Is group-term life insurance taxable?
There are both taxable and nontaxable fringe benefits. Group-term life insurance is a nontaxable fringe benefit, but only up to a certain amount.
The first $50,000 of group-term life insurance coverage you pay for is excluded from each employee’s taxable income. If you pay for more than $50,000, you must include the excess in the employee’s taxable income.
The excess is subject to Social Security and Medicare taxes but not federal income and federal unemployment taxes. Group-term life insurance for employees is always exempt from federal income and unemployment taxes (also called FUTA tax).
Some employers pay for the first $50,000 of group-term life insurance coverage and offer additional coverage at the employee’s expense. If the employee pays for the additional group-term life insurance coverage after $50,000, do not count their contribution as taxable income. If you pay part of the additional coverage and the employee pays part, do not count their contributions as taxable income.
Group-term life insurance for dependents
If you pay for $2,000 of group-term life insurance coverage for an employee’s dependents, it is exempt from the employee’s taxable income. If the dependent exceeds the $2,000 mark, you must include the entire value in the employee’s taxable income.
Unlike group-term life insurance for employees, dependent group-term life insurance coverage is subject to federal income, Social Security, and Medicare taxes, but not FUTA tax. Again, do not count any amounts that employees pay for the coverage.
Reporting group-term life insurance tax
Unless you pay for group-term life insurance policies over $50,000, you don’t need to worry about reporting the amount. However, you must report your costs toward any group-term life insurance over $50,000 as taxable income (Social Security and Medicare taxes) for each employee.
Include the taxable income for the additional amount (over $50,000) on each employee’s Form W-2. Add the taxable income to their taxable income in boxes 1, 3, and 5. You also need to mark the amount in box 12 with code C.
If the employee’s dependent receives coverage over $2,000, add the amount to the employee’s Form W-2.
To figure out how to determine the taxable income from the amount of coverage, continue reading.
Taxable cost of group-term life insurance
If you want to know how much to include on your employees’ Form W-2 as taxable income, you need to know the cost of group-term life insurance. The cost depends on how much each employee receives in life insurance coverage and their age.
Regardless of your actual costs, refer to the uniform premiums in IRS’s Section 79 Table I. These costs are what you will use to determine the taxable cost for each employee.
This chart shows the cost per $1,000 of protection each month:
Your employee’s taxable income depends on the amount of group-term life insurance coverage you provide in excess of $50,000. Remember not to include the first $50,000 in the employee’s taxable income.
If your employees pay any part of the group-term life insurance premium, deduct their contribution amount.
Example of group-term life insurance tax
You provide $100,000 in group-term to your employees, William and Charlotte. To get started, you will need to answer a few questions:
- What are their monthly costs?
- How much in excess of $50,000 is the coverage?
- How much is the yearly cost of coverage per employee?
What are their monthly costs?
To determine how much each employee’s monthly costs are, you need to know their ages. William is 26 years old and Charlotte is 57.
Now, consult the chart.
Because William is 26, his group-term life insurance costs $0.06 per $1,000 each month. Charlotte’s group term life insurance costs $0.43 per $1,000 each month because she is 57 years old.
How much in excess of $50,000 is the coverage?
Because you want to provide $100,000 in coverage, the excess of $50,000 is also $50,000. Now, divide $50,000 by $1,000 because the premiums are per $1,000 of insurance. You end up with 50. You will need this number in the next step.
How much is the yearly cost of coverage per employee?
Let’s start with William. Multiply his premium by his amount of coverage divided by $1,000 (50) to get the monthly cost. Then, multiply by 12 to find out how much to report on Form W-2.
Group-term Life Insurance Monthly Taxable Income: $0.06 X 50 = $3
Group-term Life Insurance Annual Taxable Income: $3 X 12 = $36.00
Add $36 to William’s taxable income on his Form W-2. You will add this amount to his total taxable income in boxes 1, 3, and 5. And, record the $36 in Form W-2 box 12 with code C.
Now, let’s find Charlotte’s yearly cost. Multiply her premium of $0.43 by 50. Then, multiply by 12 to find the annual amount.
Group-term Life Insurance Monthly Taxable Income $0.43 X 50 = $21.50
Group-term Life Insurance Yearly Taxable Income: $21.50 X 12 = $258.00
Add $258 to Charlotte’s taxable income on her Form W-2 to boxes 1, 3, and 5. Record the $258 in box 12 with code C.
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This is not intended as legal advice; for more information, please click here.
Read About Group Term Life Insurance
Calculating the Value of Group Term Life Insurance
by Robert W. Ditmer, CPP*
One of the more common benefits that employers provide employees is group term life insurance. But unlike other fringe benefits whose taxable value is based on the cost to the employer, group term life insurance is treated differently.
The general rule for taxing fringe benefits is that all fringe benefits are taxable to the recipient based on the fair market value, and the provider of the benefit is responsible for withholding federal income taxes, FICA taxes (social security and Medicare), and paying FUTA taxes. The taxes may be withheld from the recipient’s cash compensation. The fair market value of the fringe benefit may be reduced, however, by the following amounts:
Although the fair market value of group term life insurance (which we will refer to as GTL throughout the rest of this article) is subject to federal income tax, it is not subject to federal income tax withholding. But its value is subject to withholding for social security and Medicare taxes (commonly referred to as FICA taxes). The value of GTL, however, is not subject to FUTA tax.
So how should employers calculate the fair market value (FMV) of an employee’s GTL? Rather than being based on the cost of the premiums for the GTL, the FMV is based on the IRS Uniform Premium Table I and the employee’s age as of December 31 of the year in which the benefit is provided. (Table I is located on page 11 of IRS Publication 15-B and is reproduced to the left.) Using the table the employer calculates the monthly FMV based on the face value benefit of the policy.
Federal law does allow a portion of the GTL’s fair market value to be excluded from an employee’s income. The first $50,000 of GTL on the employee can be excluded from the employee’s taxable compensation. GTL on an employee’s dependents can be treated as a de minimus fringe benefit if the coverage on any dependent covered by the policy is $2,000 or less. If the dependent coverage on any dependent is greater than $2,000, then the FMV of the entire benefit must be included in the employee’s income based on the highest face value.
Since the FMV of GTL is based on an individual’s age, the question arises regarding whose age to use for dependent coverage. If the employer provides individual policies on each of an employee’s dependents, then the spouse’s age or the dependent’s age as of December 31 can be used. If, however, all of an employee’s dependents are covered under a single policy that is part of the employee’s GTL, then the employer must use the employee’s age as of December 31.
To illustrate, suppose an employer has a policy of providing GTL coverage on the employee equal to twice the employee’s annual salary, and the dependent coverage provides $5,000 in spousal coverage and $1,500 on each child. If the employee were paid $35,000 per year, then he would receive $70,000 in coverage. Since the first $50,000 in coverage on the employee can be excluded, only $20,000 of coverage on the employee is taxable. However, since the spousal coverage is greater than $2,000, the entire $5,000 in coverage on the spouse is also taxable. So the employee’s taxable coverage would be based on $25,000. Please note the fact that even if the coverage on children were greater than $2,000 as well, the value of the dependent coverage would still be based on the value of the highest coverage as long as all of the employee’s dependents are included in a single policy as part of the employee’s GTL rather than on individual policies.
Suppose an employee is able to purchase additional coverage through his employer, and his employer simply has the employee pay the additional premiums through a payroll deduction. The taxable value of the benefit still has to be calculated using the IRS table rather than what is paid in premiums. Anything that is paid by the employee can be deducted from the FMV of the benefit.
The employee is always responsible for paying the FICA taxes on the value of the GTL. In most cases, the value can be added to a paycheck before the end of the year and the FICA taxes withheld from the employee’s regular paycheck. This must be done at least once per year, but employers have the option of adding the value of the GTL to the employee’s pay and withholding the taxes more frequently. The value is not subject to income tax withholding. If, however, the employer is unable to collect the FICA taxes before the end of the year, or the employee is terminated before the tax can be withheld, the employee is still responsible for paying the employee portion of the FICA tax. The employer must pay the employee’s share of the FICA taxes, but the value of the tax paid must be added to the employee’s wages using the gross-up method. (The gross-up method is described in IRS Publication 15-A on page 19 under the heading of “Employee’s Portion of Taxes Paid by Employer.”)
In addition to calculating the value of the benefit, an employer must be able to correctly report the value of the benefit. The value of the benefit must be included in Box 1 of the employee’s Form W-2 and in Box 12 with Code C. In addition, the value must be included in Boxes 3 and 5 for social security and Medicare wages, and the taxes withheld should be reported in Boxes 4 and 6.
Although the FMV of GTL is not taxable for FUTA purposes, it must still be reported on Form 940 at the end of the year. The value should be included on Line 1 of Part I of Form 940, and it should be reported as excludable wages on Line 2.
Pennsylvania is the only state that does not tax the value of the GTL, so employers must also include the value of GTL in the employee’s income for state purposes on the Form W-2.
So let’s consider a practical example based on the following assumptions:
- Insurance value is $100,000
- Employee pays $5.25/month for excess insurance
- Employee is 52 years old on August 1, 2003
- Employee is hired on March 1, 2003 and coverage begins April 1
Calculate the Fair Market Value of the employee’s coverage as follows:
If we assume that the employee did not reach the social security limit for the year, calculate the FICA taxes as follows:
The fringe benefit should be reported on the employee’s Form W-2 as follows:
Now let’s modify our scenario slightly. Suppose that the employee is covered from January to September and is terminated in September 2003. The employer calculates the GTL only once per year and withholds the tax from the last paycheck each year, so the taxes have not been withheld from the terminated employee’s pay. Since the employee is still responsible for paying the FICA taxes, the employer must gross up the value of the benefit so the taxes are included in the employee’s income.
Calculate the gross-up amount and the taxes as follows:
Now the benefit would be reported on the employee’s form W-2 as follows:
In some cases an employer may continue to provide GTL to former employees (including retirees). If that is the case, the former employee is still responsible for paying the FICA taxes, but since the individual is no longer actively employed, the employer cannot withhold the tax. However, the former employee must pay the tax on his annual Form 1040. Even though the individual is no longer an employee, he should still be provided with a Form W-2 reporting the benefit.
Suppose the former employee is 62 at the end of the year and is covered under a policy for $120,000 for the entire year. Calculate the benefit as follows:
So the former employee would receive a Form W-2 containing the following amounts:
The above covers the basic situation for most employers who provide GTL to their employees, but there are some exceptions and restrictions that I have not discussed. Two primary exceptions have to be noted:
So if employers follow the guidelines provided above, they should be able to provide employees with group term life insurance and be able to calculate and report the value of the benefit properly.