Group-Term Life Insurance as an Employee Benefit

Group-Term Life Insurance As an Employee Benefit

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 and requires special calculations.

Fringe benefits are generally taxable to the recipient based on the fair market value (FMV), and the provider of the benefit is responsible for withholding taxes on the amount, including federal income, social security, Medicare, and possibly state and local income taxes. Employers also have to include the FMV in the calculation of FUTA taxes.

However, the FMV may be reduced by the following amounts:

Any amount that the law excludes from compensation, and
Any amount that the recipient pays for the benefit.

IRS Publication 15-B, Employer's Tax Guide to Fringe Benefits, states that the cost of the first $50,000 of group-term life insurance (GTL) can be excluded from the wages of an insured employee. The excess cost is subject to the withholding of social security and Medicare taxes, but federal income taxes do not have to be withheld on the benefit (although employers have the option of withholding it), and it is not subject to the FUTA tax.

How Is the Fair Market Value of Group-Term Life Insurance Calculated?

Unlike other fringe benefits, the excess cost must be calculated using Table 2-2 located on page 13 of Publication 15-B.

The FMV of the excess coverage must be calculated for each month the employee is covered during the calendar year based on the employee's age as of December 31.

For instance, suppose that the employee turns 45 on July 1, and he is covered by $90,000 of GTL from January to September, at which time he is terminated. The calculation would be as follows:

Calculate the value of excess insurance. ($90,000 - $50,000 = $40,000)
Divide the excess value by $1,000. ($40,000 / $1,000 = 40)
Find employee's age as of December 31 in Table 2-2. ($0.15 per $1,000 per month)
Multiply the cost by the factor from the second step. ($0.15 x 40 = $6.00)
Multiply the monthly cost by the number of months worked in the calendar year. ($6.00 x 9 = $54.00)

Although the excess cost must be calculated for each month of coverage, employers are only obligated to add the value of the GTL to the employee's payroll and withhold the social security and Medicare taxes once a year by December 31. Many employers will add the value and withhold taxes once a month, but some only do the calculations once a year.

In the above example the employee was terminated at the end of September, so he has no wages to withhold the FICA taxes from in December. In that case, the employer has to pay the taxes, but the taxes have to be added to the employee's wages and are subject to taxes.

Page 22 of IRS Publication 15-A, Employer's Supplemental Tax Guide, provides detailed instructions on how to gross up amounts when the employer has to pay the employee's taxes. If the employee's annual wages are less than a certain amount ($108,049.50 in 2014), then the calculation can be performed as follows:

Calculate the tax factor by subtracting the tax rates (6.2% for social security and 1.45% for Medicare) from 1. (1 - .062 - .0145 = .9235)
Divide the FMV of the GTL by the tax factor. ($54.00 / .9235 = $58.48)
Calculate the social security tax. ($58.48 x 6.2% = $3.63)
Calculate the Medicare tax. ($58.48 x 1.45% = $0.85)

If the employee's annual wages are greater than the annual limit, then use the more detailed calculations found in Publication 15-A.

How Is the Value of GTL Reported on Form W-2?

The FMV of GTL always has to be reported in Box 12 with Code C. However, it is important to note that it is the actual FMV that is reported in that box and not any gross-up amounts. For instance, the above example would be reported on the Form W-2 as follows:

Add $58.48 to the totals in boxes 1, 3 and 5.
Add $3.63 to the total in Box 4.
Add $0.85 to the total in Box 6.
Enter $54.00 in Box 12 with Code C. (Note that the gross-up included in Boxes 1, 3 and 5 is not included in this box.)

What Factors Can Affect the Amount of Excess Coverage?

In the above example we only considered coverage on the employee provided by the employer. But employees may often purchase supplemental coverage, and an employee's dependents may also receive coverage through the employee's employer. All of this additional coverage must be included in the calculations.

As regards dependent coverage, Publication 15-B states: “Group-term life insurance coverage paid by the employer for the spouse or dependents of an employee may be excludable from income as a de minimus fringe benefit if the face amount is not more than $2,000.” If the coverage is greater than $2,000, then the entire amount must be included in the calculation of the FMV.

Suppose the employee in the above example also received $5,000 of coverage on his wife, and he purchased an additional $60,000 in coverage at a cost of $7.50 per month.

Calculate the sum total of the face value of all coverage. ($90,000 employer-provided + $5,000 spousal coverage + $60,000 supplemental = $155,000)
Calculate the value of excess insurance. ($155,000 - $50,000 = $105,000)
Divide the excess value by $1,000. ($105,000 / $1,000 = 105)
Find employee's age as of December 31 in Table 2-2. ($0.15 per $1,000 per month)
Multiply the cost by the factor from the third step. ($0.15 x 105 = $15.75)
Subtract the premiums paid by the employee. ($15.75 - $7.50 = $8.25)

Are There Any Exceptions to the Details Provided Above?

The above discussion covers the basic situation for most employers who provide GTL to the employee, but there are some exceptions and restrictions that have not been discussed, but which are discussed in detail in Publication 15-B. Some notable points include the following:

None of the value of GTL is taxable if (1) the beneficiary is the employer, (2) the beneficiary is a charitable organization, or (3) the employee is permanently disabled.
2% shareholders of an S-Corporation are not considered to be employees of the corporation. Therefore, the entire value 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 employer fits the definition of group-term life insurance. IRS Publication 15-B 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 employer pays in premiums) must be included in the employee's taxable compensation.

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.