Many employers provide life insurance as a benefit to their employees. This benefit can generate taxable income which must be included in the employees’ W-2s.
What is group-term life insurance?
Life insurance must meet the following conditions to be considered group-term life (GTL) insurance for this purpose:
- It provides a general death benefit that is excludable from the recipient’s gross income;
- It is provided to a group of employees;
- It is provided under a policy carried directly or indirectly by the employer; and
- The amount of insurance provided to each employee is computed under a formula that precludes individual selection.
GTL does not include the following insurance:
- Insurance that does not provide a general death benefit, such as travel insurance or a policy covering only accidental death.
- Insurance on the life of the employee’s spouse or dependent.
- Insurance that provides a permanent benefit, such as a cash surrender value.
Provided to a group
As a general rule, insurance does not qualify as group-term unless, at some time during the calendar year, it is provided to at least 10 full-time employees who are members of the group. If you do not meet the 10-person requirement, insurance can still qualify if these conditions are met:
- The insurance is provided to all full-time employees of the employer or, if evidence of insurability affects eligibility, to all full-time who provide evidence of insurability satisfactory to the insurer;
- Evidence of insurability affecting employee’s eligibility for insurance or the amount of insurance provided to that employee is limited to a medical questionnaire completed by the employee that does not require a physical examination; and
- The amount of insurance provided is computed either as a uniform percentage of compensation or on the basis of coverage brackets established by the insurer.
- In general, no bracket may exceed 21/2 times the next lower bracket and the lowest bracket must be at least 10 percent of the highest bracket.
Computed under a formula
The amount of insurance coverage must be calculated by a formula which is based on factors such as compensation, age, years of service, or position. Common formulas include multiples of the employee’s annual salary (1X, 1.5X, 2X, etc.), or annual salary plus a fixed amount (e.g. 1X annual salary plus $30,000).
S-corporation shareholders
Shareholder-employees of an S corporation who own 2% or more of the stock of the corporation are not considered employees for purposes of GTL. In general, the amount of the premiums paid on their behalf is includable in W-2 income.
Tip: There is no taxable benefit if the employer is the beneficiary of the policy, as in a “key man” policy.
What amount is taxable?
The amount of the taxable benefit to the employees is based on the amount of insurancecoverage, not the amount of the premiums paid.
$50,000 exclusion
There is no taxable income for the first $50,000 of coverage.
Example 1
Gecko Company provides life insurance coverage to more than ten employees. The amount of coverage is the employee’s annual salary, rounded up to the next thousand. Helen is covered under the plan and has an annual salary of $40,500. Helen’s group-term life insurance coverage is $41,000 ($40,500 rounded up to the next thousand). Since Helen’s coverage is under $50,000, she receives no taxable income from the insurance benefit, and nothing needs to be added to her W-2.
Coverage over $50,000
The taxable amount for coverage over $50,000 is calculated by an IRS formula. To make the calculation you need the following information for covered employees:
- The amount of the employee’s life insurance coverage exceeding $50,000;
- The age of the employee at the end of the calendar year; and
- The number of months that the employee was covered during the year.
The value of the coverage is taken from this IRS chart. Note that the value is per month, andper $1,000 of coverage. Since life insurance premiums increase with age, the taxable benefit also increases with age.
|
Employee’s age at end of year |
Cost per $1,000 coverage for one month |
|
Under 25 |
.05 |
|
25 to 29 |
.06 |
|
30 to 34 |
.08 |
|
35 to 39 |
.09 |
|
40 to 44 |
.10 |
|
45 to 49 |
.15 |
|
50 to 54 |
.23 |
|
55 to 59 |
.43 |
|
60 to 64 |
.66 |
|
65 to 69 |
1.27 |
|
70 and above |
2.06 |
Example 2
Janet was covered under Gecko’s plan for all of 2013. Her annual salary, and her coverage amount, is $90,000. Janet was 37 years old at the end of the year.
First take her coverage amount, subtract the $50,000 exclusion, and express it in thousands:
- $90,000 – $50,000 = $40,000 / $1,000 = 40
Then multiply the result by the number of months of coverage, and by the amount from the table corresponding to the employee’s age:
- 40 (from the first step) X 12 (months of coverage) X .09 (from IRS chart) = $43.20
$43.20 must be included as taxable income in Janet’s W-2.
Example 3
The taxable income is relatively minor for younger and lower-paid employees, but can be significant for older and higher-paid employees.
Mike was covered under Gecko’s plan for the entire year. His coverage amount was $210,000, and he was 62 years old at the end of the year. Following the steps from Example 2 we get:
- $210,000 – $50,000 = $160,000 / $1,000 = 160
- 160 X 12 X .66 = $1,267.20
$1,267.20 must be included as taxable income in Mike’s W-2.
Employee contributions
If the employee pays part of the life insurance premiums, that amount reduces the taxable income inclusion.
Example 4
Same facts as in Example 3, but Mike contributed $25 per month ($300 for the year) for the life insurance coverage.
Mike’s W-2 inclusion is: $1,267.20 – $300.00 = $967.20
GTL and cafeteria plans
The rules are similar for GTL provided through a cafeteria plan. Special considerations with a cafeteria plan include:
- If an employee contributes toward the insurance, only payments made with after-tax dollars reduce the GTL inclusion.
- The entire amount of salary reduction and employer flex-credits through a cafeteria plan for GTL is excludable from the employee’s income.
Example 5
Champ Company’s cafeteria plan allows employees to elect salary reduction for GTL. Brice, age 42, elected salary reduction of $200 for $150,000 of GTL coverage.
The $200 salary reduction is excludable from Brice’s income.
The taxable benefit included in Brice’s W-2 is calculated in the same manner as the examples above.
- $15,000 – $50,000 = $100,000 / $1,000 = 100
- 100 X 12 X .10 = $120.00
Tax treatment of the taxable benefit
The amount of the taxable benefit is subject to:
- Social security and Medicare taxes and withholding (both the employee and employer portions).
- Federal income tax, but not federal withholding.
The taxable benefit is not subject to FUTA.
Tip: State treatment of GTL benefits varies. Be sure to check the rules for your applicable states.
The GTL taxable benefit is typically included in the last payroll of the calendar year. For employees who terminate during the year, the inclusion should be included in the last pay so that social security and Medicare can be withheld.
The GTL taxable benefit is included in Box 1, Box 3, and Box 5 of the employee’s W-2.
If you have any questions, please leave a comment.
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