Most school, city, and county employers are familiar with the imputed income rules when it relates to group term life insurance. Employers can provide their employees with up to $50,000 of group term life insurance on a tax-free basis. The premium on any life insurance amount exceeding $50,000 must be reported as income to the Internal Revenue Service (IRS). What many employers don’t know is how imputed income reporting works when it comes to contributory coverage.
Contributory coverage occurs when the employee pays any portion of the insurance premiums. If your contributory plan has age-banded or composite rates, you may be affected by imputed income.
Age-Rated Plans
With age-banded rates, you must verify if your rates ‘straddle’ the IRS table to determine if imputed income applies. Imputed income is calculated by using the uniform premium table published by the IRS. The cost of the excess coverage is based on the IRS table rate, not the rate the employer or employee is actually paying for coverage. The table contains age-banded rates and the employee’s age as of the last date of the taxable year must be used in the calculation.
Straddling is determined by comparing the age-banded rates employees pay for the coverage to the IRS table. ‘Straddling’ only occurs when at least one age band is above the (IRS) table and when at least one age band is below the table. If all age bands are at or below the table, the plan is not considered straddling and imputed income would not apply. Likewise, if all bands are at or above the table, the plan is not considered straddling.
Also note that if rates straddle the IRS table rates, the total combined value of any employer-paid and voluntary/supplemental coverage must be considered when determining each affected employee’s imputed income (where the first $50,000 is still considered tax-free).
Composite-Rated Plans
If your contributory life insurance plan has composite rates, imputed income must always be reported. Because the same rate is used for all employees, younger employees may be paying a higher rate than IRS Table while the older employers may be paying a relatively lower rate. This would also be considered straddling. Employers must make sure to report the taxable imputed income on Form W-2 for each employee whose charged premium is lower than the IRS table rate.
Pre-Tax Payroll Deductions
Schools, cities and counties should also keep in mind that taking deductions from employees pre-tax doesn’t prevent having to report imputed income. Employers can deduct the total cost the employee paid on a post-tax basis from the total imputed income calculation, therefore by making that post-tax value a “0”, the employee would assume the full cost of their coverage as imputed income.
For clients that insure their group term life insurance through National Insurance Services (NIS), we have identified those customers that are affected by the “straddling” rule and have been proactively addressing this topic and offering potential solutions on a case-by-case basis. Contact your NIS Representative if you have questions. Download our Guide to learn more.
