Life insurance imputed income is a commonly used phrase. However, very few people understand what it means.
For your information, it describes the value of benefit or service that the IRS treats as income.
So, life insurance imputed income refers to any amount paid on the cover above $50,000.
Such an amount of coverage should be subjected to federal taxes. Thus, if an employer pays for the cover, it reduces the taxable income.
Of course, life insurance cover should be tax-free.
But, when such an amount exceeds $50,000, the excess amount is considered as imputed income. The law requires that such money must be subjected to Federal, Medicare and Social Security taxes.
How Imputed Income is Computed in Group Term Life Insurance?
IRS considers whether the basic coverage is paid by the employee or the employer. The employee is mandated to supply information regarding group term life insurance covers.
They may impute income on life insurance coverage as provided during the year. Also, they could wait and do so at the end of the year. But, employees are advised to track the value of imputed income throughout the year.
Before we look at what imputed group life insurance calculations, let us delve into what group term life insurance is.
Group Term Life Insurance & Imputed Income
It refers to one of the covers employers offer to their employees.
In most cases, the employers offer a base amount to provide coverage to their employees. They may also allow employees to obtain supplement coverage through the check-off system. The plan gives the employees an opportunity to buy coverage for their children and spouses.
The amount of money the employer spends on the coverage is an income to the employee. Note that the coverage employers offer to group plans keep on changing. The amount may also vary depending on the employer and the organization’s hierarchy.
For instance, managers and executives may get robust benefits compared to lower cadre employees. The amount of coverage may be significant. Thus, the IRS may be interested in collecting its dues from the beneficiary. This is only possible if the imputed income is calculated.
The Cost of Premium in Group Term Life insurance
Group term coverage for young employees may be cheaper. But, the amount of money they pay in the group coverage may be extremely high.
Also, if the employee is advanced in age, the rates may go high as well. One of the reasons that may make the cost of the premium to go up is that some participants in the group may be advanced in age.
As such, they may not need to go through the underwriting process. But since all employees are covered, insurers take advantage of the situation. So, they increase the cost of premiums.
Also, the age and health status of the employees may not be considered. Besides, the majority of insurance companies have rate bands.
These rates in the bands go up as the age increases. It means that part of the money deducted from youthful employees is used to subsidize the aged employees.
In effect, the youthful employee pays more money through the check-off system.
Eligibility for Group Plans
Although all the employees may be automatically covered, there are a few eligibility requirements.
First, eligibility may vary depending on the organization. It could include the number of hours worked every week. It may also depend on the number of years the employee has been with the organization.
In some cases, the cover may only be available upon the occurrence of a defined life event. Such an event may include the birth of a new member of the family.
In the case of supplementary coverage, the employee may be required to answer a few questions. The questions help the insurer determine their eligibility. If the questions are not answered well, the insurer may refuse to give the coverage.
Also, a few carriers offer plans that allow the employees to buy permanent coverage. They do this through a simplified underwriting process. It allows the employees to buy some limited amount of coverage for their children and spouse.
Portability
Ideally, group term insurance may be linked to on-going employment. Unfortunately, such coverage may end as soon as the employment is terminated.
Of course, a few good insurers offer a chance to convert the cover into a permanent policy. But in some cases, the conversion may require some underwriting.
So, depending on how you are rated, you could be allowed to move the policy but pay a higher premium.
Where IRS Gets in
If the cover exceeds $50,000, the group term life cover will no longer be tax-free. Any amount above the $50,000 must be recognized as a benefit from the employer.
So, it should be declared for taxation purposes. The amount of tax you pay may be calculated using an IRS table. Thus, the group coverage may be subject to taxation if they exceed the tax-free bracket of $50,000.
When Imputed Income is Taken into Account?
The first $50,000 is excluded from the taxes but any excess coverage is subjected to income taxes. The employers are mandated to provide the excess coverage on W-2 forms. They are expected to withhold the employer’s portion of the taxes and submit them to IRS.
How to Determine the Income to Impute?
If the employer pays the premiums for the employees, the amount to impute is found by subtracting $50,000 from the group term coverage.
Whatever that remains should then be multiplied by the applicable rate. If the employee pays part of the premiums and the contributions are made on a pre-tax basis, the same formula should be followed.
But if part or all the premiums for the group term is paid by the employee, it means they make payment after tax. In such a case, it may be necessary to carry out additional calculations.
Besides, if the employee has more than one group term life, an aggregation of the coverage may be needed.
How to Calculate Imputed Income for Life Insurance?
If the employer provides a group term cover to employees, any payment above $50,000 should be treated as imputed income. Such an amount should be taxed.
Typically, the IRS considers insurance benefits as tax-exempt. But when the benefits exceed $50,000, then it must be taxed.
For instance, if a 50 years old employee receives coverage of about $200,000, the imputed income on the cover will be calculated by subtracting 50,000 from $200,000. The difference is then divided by 1000 and multiplied by 12 to arrive at the annual imputed income.
If another employee pays only $200 for the $200,000 voluntary cover, we get the difference between $200,000 and $50,000. The resultant amount is then divided by 1000 and multiplied by 12. Finally, we subtract $200 from our figure to arrive at his annual imputed income.
Generally, you must impute your life insurance coverage on the amount above $50,000. It should be done whether the policy is directly or indirectly carried by your employer.
An insurance policy is considered carried by the employer if they pay a portion of the premiums. It includes the money paid either on a pre-tax basis or through the check-off system. The IRS provides how such income could be taxed.
But, there are cases where an amount exceeding $50,000, may not be taxed even when the imputed income is calculated.
They include:
- The coverage the employer provides to any of their existing employees. The cover may be provided because they have become disabled.
- A coverage in which the employer is indirectly or directly a beneficiary.
- A coverage in which the benefits go to charity.
In some cases, when the employer rate violates the above rule by a few cents, the rates should be restructured.
This is to help avoid straddling. Straddling refers to a situation in which the employees’ rates are either too low, too high. They may also be the same as those in IRS Table I.
Also, there is a situation where the employer charges lower rates to older employees. Coincidentally, these are employees who are highly paid.
On the other hand, the employer overcharges the lowly paid workers. It results in a situation where the younger employees subsidies the cover for their senior counterparts.
Other Options
The Discriminatory Plan
There is a case where the group term life cover discriminates the employees. In such a case, the IRS requires that all the key employees include the cost of $50,000 coverage into their taxable income.
In some cases, the amount of money that is taxable from the key employees may be higher than the actual cost. If it is more as explained in IRS table I, the non-key employees may not be subjected to tax consequences.
When More Than One Insurer Provides the Cover
We have cases where more than one insurer provides coverage to the same policy. In such a case combined test must be used. The test determines whether it is carried indirectly or directly by the employer.
According to regulations, each policy must be tested separately. The test determines whether the policy is carried indirectly or directly by the employer.
What You Need to Know
- More than 55% of employees in the private sector enjoy employer-sponsored life insurance cover. Most of them are offered group term cover but they may not be aware of group term life insurance tax.
- A group-term life cover is always treated as a fringe benefit.
- The coverage does not discriminate and is not biased to favor certain employees.
- The employer can indirectly or directly carry group-term life insurance cover.
- Any person covered by group- term life insurance can choose the beneficiaries. Such a beneficiary is entitled to the benefits if the insured passes away.
- It is possible to extend group term insurance to the employee’s dependents. It can be used to cover children and their spouse.
- Group life insurance is a benefit that is non-taxable up to a certain level. Any further benefits beyond that level which is usually $50,000 must be subjected to taxes.
- The excess of $50,000 is subjected to both medical and social security taxes. But the money will not be subjected to federal unemployment taxes and federal income taxes.
- A few employers will only pay the initial $50,000 of the cover. But the employee who wishes to get more coverage may pay for it out of pocket. If this happens, the employer and the employee may pay part of the cover. In this case, the contribution does not count as a taxable income.
An employer can offer a group term cover in the following circumstances:
- When they want coverage that provides death benefits that are not included in income.
- If they have more than 10 employees. The cover is available to not less than ten full-time employees
Is Payment Of Group Term Life Cover For The Employee’s Dependents Deductible?
For group-term life insurance, you are free to pay for your dependents. However, the maximum you can pay for the dependent is $2,000.
If you pay anything above the $2000 mark, the employer must include the entire amount in the taxable income. Such an amount will be subjected to Medicare, social security as well as federal income.
However, it is exempted from FUTA tax. Also, if the employee pays any amount to this course, the amount the employee pays cannot be imputed.
Conclusion
If your group-term policy does not cost more than $50,000 there is no need of worrying about taxes. However, when the cost exceeds $50,000, you must report the same so that the imputed income is calculated for taxation purposes.
It allows the IRS to subject it to Medicare and Social Security taxes. If an employer pays for the employee’s dependents coverage to about $2,000, it should not be reported.
However, when the amount exceeds $2,000, the excess amount must be captured in the Form W-2.
