Group Term Life Insurance: Federal Income Tax Implications

Group term life insurance is a popular employee benefit, with 85% of organizations offering it and 98% of employees enrolling when it is available. It is a type of insurance policy that covers a group of people, such as employees in a business, and pays out benefits to an employee's beneficiaries in the event of their death. While group term life insurance is generally considered a nontaxable fringe benefit, there are tax implications if the coverage exceeds $50,000. In such cases, the excess amount is included in the employee's taxable income and is subject to federal income tax and Federal Insurance Contributions Act (FICA) taxes, which include Social Security and Medicare taxes.

The first $50,000 of group term life insurance is non-taxable

Group term life insurance is a popular employee benefit, with 85% of organizations offering it and 98% of employees enrolling when it is available. It is a type of insurance policy that covers a group of people, such as employees in a business, and pays out benefits to an employee's beneficiaries if the employee dies.

Group term life insurance is generally considered a fringe benefit, which is a benefit that employers offer in addition to an employee's regular wages. As per the Internal Revenue Code (IRC) Section 79, the first $50,000 of group-term life insurance coverage provided by an employer is excluded from taxable income. This means that if your employer provides you with group term life insurance coverage up to $50,000, you do not need to pay any additional taxes on this benefit. It is completely tax-free for the employee.

The exclusion applies regardless of whether the employer pays the entire cost of the insurance or whether the employee contributes to the premium payments. As long as the total coverage provided by the employer does not exceed $50,000, there are no tax consequences for the employee. This exclusion also applies for Federal Insurance Contributions Act (FICA) taxes, which include Social Security and Medicare taxes.

However, if the employer-provided group term life insurance coverage exceeds $50,000, the additional amount is considered taxable income for the employee. The cost of the insurance above $50,000, known as the imputed income or "phantom income," must be included in the employee's gross income for federal income tax purposes. This additional taxable income will be reported on the employee's Form W-2, even though the employee does not actually receive this amount as wages.

It's important to note that the determination of the cost of group term insurance coverage is based on a table prepared by the Internal Revenue Service (IRS) and may differ from the employer's actual cost. This can result in a higher tax burden for older employees as their compensation increases.

Taxable income for coverage over $50,000

Group-term life insurance is a fringe benefit, which is a benefit that employers offer in addition to an employee's regular wages. It is a nontaxable fringe benefit, but only up to a certain amount. The IRS's fringe benefit exclusion rule applies to group-term life insurance that meets the following four requirements:

• The coverage provides a general death benefit that isn't included in income.
• The employer meets the 10-employee rule (the insurance must be provided to at least 10 full-time employees at some time during the year; some exceptions apply).
• The coverage isn't biased toward certain employees.
• The employer directly or indirectly carries the policy.

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. However, the imputed cost of coverage in excess of $50,000 must be included in income and is subject to federal income tax, Social Security tax, and Medicare taxes. This is determined using the IRS Premium Table, which outlines the cost per $1,000 of coverage per month based on age. For example, a 26-year-old employee's insurance costs $0.06 per $1,000 each month, while a 57-year-old employee's insurance costs $0.43 per $1,000 each month.

If an employee receives more than $50,000 of employer-provided group-term life insurance coverage, the "cost" (imputed income) of the insurance in excess of $50,000—less any amount paid by the employee with after-tax contributions—is included in the employee's gross income for both federal income tax and Federal Insurance Contributions Act (FICA) purposes. This amount is included in the taxable wages reported on the employee's Form W-2 and is considered "phantom income" because it is taxed even though the employee does not actually receive it.

Group term life insurance is a fringe benefit

Group term life insurance is a "nontaxable fringe benefit," but only up to a certain amount. The IRS's fringe benefit exclusion rule applies to group life insurance that meets all four of the following requirements:

• The coverage provides a general death benefit that isn't included in income.
• The employer meets 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 toward certain employees.
• The employer directly or indirectly carries the policy.

If the group term life insurance meets these qualifications, the first $50,000 of coverage is excluded from the employee's taxable income. This exclusion is provided by IRC section 79, which applies to employer-sponsored group term life insurance plans. However, if the employer-provided coverage exceeds $50,000, the excess amount is included in the employee's taxable income and is subject to federal income tax and FICA (Social Security and Medicare) taxes.

It is important to note that the cost of group term insurance must be determined using a table prepared by the IRS, even if the employer's actual cost is less than the cost calculated under the table. This can result in a higher tax burden for older employees or those with higher compensation.

Group term life insurance for spouse and dependents

Group term life insurance is a common part of employee benefits packages. Many employers provide a base amount of coverage at no cost, as well as the opportunity for the employee to purchase additional coverage for themselves and their family members through payroll deductions. This type of insurance is relatively inexpensive compared to individual life insurance, and participation rates are high.

The first $50,000 of group term life insurance coverage is tax-free to the employee. According to the Internal Revenue Service (IRS) Code Section 79, the cost of any coverage over $50,000 that is paid for by an employer must be recognized as a taxable benefit and reported on the employee's W-2 form as income. The taxable amount is calculated using an IRS premium table, based on the employee's age, and is subject to Social Security and Medicare taxes.

The cost of employer-provided group-term life insurance on the life of an employee's spouse or dependent 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.

If part of the coverage for a spouse or dependent is taxable, the same Premium Table is used as for the employee. For example, 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. The cost of $10,000 of this amount is excludable, while 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.

Calculating the taxable cost of group term life insurance

Group-term life insurance is a fringe benefit, which is a benefit employers offer in addition to an employee's regular wages. It is a "nontaxable fringe benefit", but only up to a certain amount.

The Internal Revenue Code (IRC) Section 79 governs employer-sponsored group term life insurance plans and provides an income exclusion of the cost of up to $50,000 of employer-provided group term life insurance coverage. This means that the first $50,000 of group term life insurance coverage that your employer provides is excluded from taxable income and doesn't add anything to your income tax bill.

However, if the coverage is higher than $50,000, the employer-paid cost of group term coverage in excess of $50,000 is included in the employee's taxable income. This "excess" is subject to Federal Insurance Contributions Act (FICA) taxes, also known as Social Security and Medicare taxes.

To calculate the taxable cost of group term life insurance, you need to determine the monthly cost of the insurance, which depends on the coverage amount and the employee's age. The IRS has a chart that you can use to find the value of the coverage to include in the employee's taxable income. This chart shows the cost per $1,000 of life insurance coverage each month, and it is available in the group-term life insurance discussion in Publication 15-B.

For example, let's say an employer provides $100,000 in group-term coverage to two employees, William and Charlotte, who are 26 and 57 years old, respectively. According to the IRS chart, William's insurance costs $0.06 per $1,000 each month, while Charlotte's insurance costs $0.43 per $1,000 each month due to her age. To calculate the excess coverage, subtract $50,000 from the total coverage amount, which gives us $50,000. Then, divide the excess by $1,000 since the premiums are per $1,000 of insurance: $50,000 / $1,000 = 50. This number is then multiplied by the cost per $1,000 to find the monthly taxable income. For William, it is $0.06 x 50 = $3, and for Charlotte, it is $0.43 x 50 = $21.50. To find the annual taxable income, multiply the monthly amount by 12. So, William's annual taxable income for insurance is $36.00, and Charlotte's is $258.00.

It is important to note that if employees pay any part of the group-term life insurance premium, their contribution amount should be deducted from the taxable income. Additionally, if the employee pays for additional insurance coverage after $50,000, their contribution is not counted as taxable income.

Frequently asked questions