Ask Fred: Is Employee Additional Life Insurance Imputed Income?

Question: When calculating the imputed income for employer-provided group-term life insurance, my employer also allows the employee to purchase additional coverage in addition to the employer-provided coverage. Should the employee-elected additional life insurance be included in the calculation of the taxable imputed income?

Answer: So many employers raise this question and say, “This is the employee’s election, and they pay for the coverage, so we do not include that in the imputed income calculation.” Here, we will look at the rules to determine whether the additional coverage should be part of the imputed income calculation.

First, see how imputing income for GTL insurance should work.

Generally, employers must impute amounts as taxable income for employer-provided group-term life plans that exceed $50,000 in benefit value. Although employers typically don’t withhold federal income taxes, you can if it is processed with a normal pay cycle and the employee has enough net pay to absorb the taxes. On the other hand, FICA taxes generally must be withheld when the income is determined, and these amounts are reportable on Form W-2, Wage and Tax Statement.

Here is a typical calculation. Say the employer provides the employee with one times their annual salary at no cost to the employee. If the employee earns $60,000 per year, they are provided with $60,000 of group term life insurance coverage. The first $50,000 is tax free, so only the remaining $10,000 would be taxable income to be imputed.

The IRS provides an imputed table based on the insured age as of Dec. 31 of the current year, in Publication 15-B, Employer’s Tax Guide to Fringe Benefits. The table is used to calculate the monthly cost of insurance to include in employees’ wages. The rates are based on cents per $1,000 in coverage per month.

In our example, say the employee is in the 40 to 44 age bracket. According to the table, the imputed income would be 10 cents per $1,000 of coverage. In this case, $10,000 of excess is 10 units ($10,000 / 1,000). Each unit is 10 cents, so 10 units equals $1 of imputed income. In our example, if the employee had the $60,000 of insurance coverage for all 12 months of the year, the imputed income would be $12 ($1 x 12 months).

Now that we know the basics, we can introduce the complexity of additional coverage the employer may offer to the employee. When teaching payroll classes, I often hear participants refer to this as “supplemental life” or “optional life.” My typical response is “Let’s take a look at the types of life insurance offered to the general public.”

In general, the types of life insurance for purchase on the open market include whole life, ordinary life, universal life, and term life.

There is no such thing as “supplemental life” or “optional life,” but we can work with these terms. I ask participants, “What kind of supplemental or optional life is being offered? Is it supplemental whole, supplemental ordinary, supplemental universal, or supplemental term?”

The concern here is whether the employer offers any additional “term” life insurance for the employee to purchase. If it is the same term life insurance that the employer is paying for the employee, then we need to determine whether the employee-paid portion should be included in the imputed income calculation.

We can determine if it should be included by using the IRS straddle test, which considers coverage taxable if it is “carried directly or indirectly” by the employer. Specifically, the rule applies if the “premiums paid by at least one employee subsidize those paid by at least one other employee.”

In layman’s terms, this means we need to look at how many cents per $1,000 of coverage the employer is charging the employee for the extra coverage. Most employers’ coverage offered for the employee to purchase is based on cents per $1,000 and the employee’s age.

If the rates charged by the employer are all lower or higher than the IRS tables rates, it is not directly carried by the employer. However, if one age bracket charge is higher than the IRS table and some age bracket charges are lower than the IRS table, then the coverage is directly carried by the employer, and therefore the insured coverage amount should be included in the imputed income calculation.

If the employer of the employee in the previous example charged rates to employees, some being higher than the IRS table’s rates and some being lower than the IRS table’s rates, the straddle test would not be met. In that case, any additional amount paid by employees for extra coverage would be considered taxable income.

However, assume instead that the employee elects to purchase additional coverage equaling twice their annual salary of $60,000 at a cost of $5 per month. This would result in total life insurance coverage of $180,000 ($60,000 employer-provided coverage and $120,000 of additional coverage).

Remember, the first $50,000 of the coverage is tax free, so only the remaining $130,000 in coverage would be subject to taxation. Using the IRS table, we can see that this equals 130 units of coverage. Since the employee is in the age 40 to 44 bracket, which has a 10-cent monthly cost per $1,000 in coverage, this equates to $13 per month being potentially subject to imputing. However, we subtract the $5 per month that the employee pays for the extra coverage, resulting in $8 of taxable income per month.

We can see how an employee’s monthly cost of extra coverage can affect taxable income. If the employee were to pay $20 per month for the extra coverage instead of $5, that would exceed the $13 per month value determined by the IRS table, so none of the group-term life insurance would be taxable.

Many employers take the stance that they only take into consideration the amount the employer pays for and not the amount the employee purchases. If that were the case, in our example, the employer would have imputed $13 per month. However, since the employee paid $20 per month as well for the extra coverage, the employee could have been overtaxed.

Any amount of coverage determined to be taxable should be reported on an employee’s Form W-2 in Boxes 1, 3, and 5, which are used for reporting total wages and FICA taxes. Additionally, the amount should be included in Box 12 using Code C. If the employee is in a state that requires group-term life insurance reporting, the amount must be added to state wages and reported in Box 16.

This column does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information
Fred A. Basehore, Jr., CPP, is owner of F.A. Basehore & Associates offering payroll and payroll tax compliance services and a member of the Bloomberg Tax Payroll Advisory Board. Do you have a payroll question for Ask Fred? Send it to fabjrcpp@yahoo.com.