Group Life Insurance - It’s Real Value

One of the more ordinary benefits that companies provide staff is group term life insurance. But unlike other fringe benefits whose taxable worth is based on the cost to the company, group term life insurance is treated in a different way.

The universal rule for taxing fringe benefits is that all fringe benefits are taxable to the recipient based on the fair market cost, and the provider of the benefit is accountable 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 payment. The fair market cost of the fringe benefit may be condensed, however, by the following amounts:

1.    Any quantity that the law excludes from payment; and

2.    Any quantity that the recipient pays for the protection.

 

Even though the fair market worth of group term life insurance (also knows as GTL) is subject to federal income tax, it is not subject to federal income tax withholding. But its cost is subject to withholding for social security and Medicare taxes (commonly referred to as FICA taxes). The rate of GTL, however, is not subject to FUTA tax.

 

So how should companys compute the fair market worth (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 given. (Table I is located on page 11 of IRS Publication 15-B and is reproduced to the left.) Using the table the company estimates the monthly FMV based on the face worth benefit of the plan.

Federal law does allow a fraction of the GTL’s fair market worth to be expelled from an employee’s income. The first $50,000 of GTL on the employee can be excluded from the employee’s chargeable payment. GTL on an employee’s dependents can be treated as a de minimums border benefit if the exposure on any dependent sheltered 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 worth.

Since the FMV of GTL is based on an individual’s age, the question arises concerning whose age to use for dependent coverage. If the company provides one-person 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 solitary policy that is part of the employee’s GTL, then the company must use the employee’s age as of December 31.

To demonstrate, presume an company has a policy of providing GTL coverage on the employee equal to twice the employee’s yearly salary, and the dependent coverage provides $5,000 in spousal coverage and $1,500 on each infant. If the employee were salaried $35,000 per year, then he would collect $70,000 in coverage. Since the first $50,000 in coverage on the employee can be disqualified, only $20,000 of coverage on the employee is taxable. On the other hand, since the spousal coverage is superior to $2,000, the whole $5,000 in coverage on the partner 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 offspring were greater than $2,000 as well, the worth of the dependent coverage would still be based on the worth of the highest coverage as long as all of the employee’s dependents are incorporated in a sole policy as part of the employee’s GTL rather than on individual policies.

Suppose an employee is able to purchase supplementary coverage through his company, and his company merely has the employee pay the additional premiums through a payroll withdrawal. The taxable worth of the assistance still has to be considered using the IRS table rather than what is salaried in premiums. No matter which that is salaried by the employee can be deducted from the FMV of the benefit.

The employee is always accountable for paying the FICA taxes on the worth of the GTL. In nearly all cases, the worth can be added to a salary before the end of the year and the FICA taxes withheld from the employee’s regular income. This must be done at least once for each year, but companies have the choice of totaling the worth of the GTL to the employee’s pay and maintenance the taxes more frequently. The worth is not subject to income tax withholding. If, however, the company is not capable to collect the FICA taxes before the last part of the year, or the employee is fired before the tax can be withheld, the employee is still accountable for paying the employee portion of the FICA tax. The company must pay the employee’s share of the FICA taxes, but the worth of the tax salaried must be added to the employee’s wages using the gross-up method. (Company describes the gross-up method in IRS Publication 15-A.”)

In addition to calculating the worth of the benefit, a company must be able to correctly report the worth of the benefit. The worth 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 worth 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 worth 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 worth of the GTL, so companies must also include the worth 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 worth 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 Worth of the employee’s coverage as follows:

·      Calculate the worth of excess insurance. ($100,000 - $50,000 = $50,000)

·      Divide the excess worth by $1,000. ($50,000 / $1,000 = 50)

·      Find employee’s age as of December 31 in Table I. ($0.23 per $1,000 per month)

·      Multiply the cost by the factor from the second step. ($0.23 x 50 = $11.50)

·      Subtract any premiums salaried by the employee. ($11.50 - $5.25 = $6.25)

·      To calculate the annual amount, multiply by the number of months covered. ($6.25 x 9 months = $56.25)

If we presume that the employee did not reach the social security limit for the year, calculate the FICA taxes as follows:

·      Social security tax. ($56.25 x 6.2% = $3.49)

·      Medicare tax. ($56.25 x 1.45%) = $0.82)

The fringe benefit should be reported on the employee’s Form W-2 as follows:

·      Add $56.25 to the totals in Boxes 1, 3 and 5.

·      Add $3.49 to the total in Box 4.

·      Add $0.82 to the total in Box 6.

·      Enter $56.25 in Box 12 with Code C.

Now let’s modify our scenario slightly. Suppose that the employee is covered from January to September and is terminated in September 2003. The company estimates 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 accountable for paying the FICA taxes, the company must gross up the worth of the benefit so the taxes are included in the employee’s income.

Calculate the gross-up amount and the taxes as follows:

·      Calculate the tax factor by subtracting the tax rates from 1. (1 - .062 - .0145 = .9235)

·      Divide the benefit by the tax factor. ($56.25 / .9235 = $60.91)

·      Calculate the social security tax. ($60.91 x 6.2% = $3.78)

·      Calculate the Medicare tax. ($60.91 x 1.45% = $0.88)

·      Now the benefit would be reported on the employee’s form W-2 as follows:

·      Add $60.91 to the totals in Boxes 1, 3 and 5.

·      Add $3.78 to the total in Box 4.

·      Add $0.88 to the total in Box 6.

·      Enter $56.25 in Box 12 with Code C. (Note that the gross-up is not included in this Box.)

In some cases an company may continue to provide GTL to former employees (including retirees). If that is the case, the former employee is still accountable  for paying the FICA taxes, but since the individual is no longer actively employed, the company 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:

·      Calculate the worth of excess insurance. ($120,000 - $50,000 = $70,000)

·      Divide the excess worth by $1,000. ($70,000 / $1,000 = 70)

·      Find former employee’s age as of December 31 in Table I. ($0.66 per $1,000)

·      Multiply the cost by the factor from the second step. ($0.66 x 70 = $46.20)

·      Multiply by the number of months covered. ($46.20 x 12 months = $554.40)

·      Social security tax. ($554.40 x 6.2% = $34.37)

·      Medicare tax. ($554.40 x 1.45% = $8.04)

So the former employee would receive a Form W-2 containing the following amounts:

·      Report $554.40 in Box 1, 3 and 5

·      Report $554.40 in Box 12 with Code C.

·      Report $34.37 in Box 12 with Code M. (Uncollected tax)

·      Report $8.04 in Box 12 with Code N. (Uncollected tax)

The above covers the basic situation for most companys 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:

·      2% shareholders of an S corporation are not considered to be employees of the corporation. Therefore, the entire worth of the insurance coverage is taxable income. The $50,000 exclusion does not apply.

·      The $50,000 exclusion applies only if the insurance that is provided by the company fits the definition of group term life insurance. IRS Publication 15-B, Company’s Tax Guide to Fringe Benefits contains guidelines regarding what is and what is not GTL. If the insurance does not qualify as GTL, then the cost of the insurance (what the company pays in premiums) must be included in the employee’s taxable compensation.

So if companys 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 worth of the benefit properly.