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How Are Employees Taxed If They Pay for Group-Term Life Insurance Through a Cafeteria Plan?




QUESTION: Our company would like to offer a group-term life insurance benefit to employees, but we can’t afford to pay any of the premiums. Could our employees pay the premiums for their coverage through our cafeteria plan? If so, how will their coverage be taxed?

ANSWER: Group-term life insurance coverage on employees’ lives can be offered through a cafeteria plan, with employees purchasing some or all of their coverage with pre-tax salary reduction contributions. (Other types of life insurance—e.g., insurance on the life of anyone other than an employee or term coverage combined with permanent benefits such as a cash surrender value—cannot be offered through a cafeteria plan.) Under IRS regulations, pre-tax salary reductions are treated as employer contributions, regardless of the amount of coverage purchased, and are not subject to federal income or employment taxes.

Code § 79 allows employees to exclude from their gross income the cost of up to $50,000 in employer-provided group-term life insurance coverage. Thus, if your employees purchase no more than $50,000 of employer-provided group-term life insurance coverage with pre-tax contributions under your cafeteria plan, they will not pay federal taxes on the coverage. If your employees purchase more than $50,000 of coverage with pre-tax contributions under the cafeteria plan, the pre-tax premiums will still be tax-free, but the value of the coverage in excess of $50,000 will be subject to federal income and FICA taxes. The taxable value of the excess coverage will be determined using its cost as indicated in an IRS table known as “Table I.” The Table I cost of coverage varies based on the employee’s age and may be greater or less than what the employee actually pays. If any portion of an employee’s premiums are paid on an after-tax basis, the after-tax premiums will reduce the taxable coverage value, dollar for dollar. The taxable amount is sometimes referred to as “imputed income.” Imputed income in this case is not subject to federal income tax withholding, but FICA taxes must be withheld.

For example, if a 42-year-old employee purchases $150,000 of group-term life insurance coverage under a cafeteria plan with $200 of pre-tax salary reduction contributions, none of the $200 would be taxed, and the first $50,000 of coverage would not be taxed. But the cost (as determined by Table I) of the remaining $100,000 of coverage would be treated as taxable income to the employee. For this employee, the Table I cost of $100,000 of coverage would be $120 per year, so the employee would be taxed on that amount of imputed income. If the employee were allowed to pay for a portion of the coverage with after-tax contributions, and $100 of the premiums were actually paid with after-tax contributions, the $100 in after-tax contributions would be subtracted from the $120 Table I cost for the coverage in excess of $50,000. The employee’s imputed income on the $100,000 of excess coverage would then be $20 ($120 minus $100).

For more information, see EBIA’s Fringe Benefits manual at Section XIV.C (“Tax Consequences of Group-Term Life Insurance Subject to Code § 79”) and EBIA’s Cafeteria Plans manual at Section X.B.3 (“Group Term Life Insurance Coverage”).

Contributing Editors: EBIA Staff.

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