by Robert W. Ditmer, CPP*
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.
The general rule for taxing fringe benefits is that all fringe benefits are taxable
to the recipient based on the fair market value, and the provider of the benefit
is responsible 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 compensation. The fair market value of the fringe benefit may be reduced,
however, by the following amounts:
- Any amount that the law excludes from compensation; and
- Any amount that the recipient pays for the benefit.
Although the fair market value of group term life insurance (which we
will refer to as GTL throughout the rest of this article) is
subject to federal income tax, it is not subject to federal
income tax withholding. But its value is subject to withholding
for social security and Medicare taxes (commonly referred to
as FICA taxes). The value of GTL, however, is not subject to FUTA tax.
So how should employers calculate the fair
market value (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 provided.
(Table I is located on page 11 of IRS Publication 15-B and is
reproduced to the left.) Using the table the employer calculates
the monthly FMV based on the face value benefit of the policy.
Federal law does allow a portion of the GTL’s fair market
value to be excluded from an employee’s income. The first
$50,000 of GTL on the employee can be excluded from the employee’s
taxable compensation. GTL on an employee’s dependents can
be treated as a de minimus fringe benefit if the coverage on
any dependent covered 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 value.
Since the FMV of GTL is based on an individual’s age,
the question arises regarding whose age to use for dependent
coverage. If the employer provides individual 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 single policy that is part of the employee’s GTL, then
the employer must use the employee’s age as of December
31.
To illustrate, suppose an employer has a policy of providing
GTL coverage on the employee equal to twice the employee’s
annual salary, and the dependent coverage provides $5,000 in
spousal coverage and $1,500 on each child. If the employee were
paid $35,000 per year, then he would receive $70,000 in coverage.
Since the first $50,000 in coverage on the employee can be excluded,
only $20,000 of coverage on the employee is taxable. However,
since the spousal coverage is greater than $2,000, the entire
$5,000 in coverage on the spouse 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 children were greater than $2,000
as well, the value of the dependent coverage would still be based
on the value of the highest coverage as long as all of the employee’s
dependents are included in a single policy as part of the employee’s
GTL rather than on individual policies.
Suppose an employee is able to purchase additional coverage
through his employer, and his employer simply has the employee
pay the additional premiums through a payroll deduction. The
taxable value of the benefit still has to be calculated using
the IRS table rather than what is paid in premiums. Anything
that is paid by the employee can be deducted from the FMV of
the benefit.
The employee is always responsible for paying the FICA taxes
on the value of the GTL. In most cases, the value can be added
to a paycheck before the end of the year and the FICA taxes withheld
from the employee’s regular paycheck. This must be done
at least once per year, but employers have the option of adding
the value of the GTL to the employee’s pay and withholding
the taxes more frequently. The value is not subject to income
tax withholding. If, however, the employer is unable to collect
the FICA taxes before the end of the year, or the employee is
terminated before the tax can be withheld, the employee is still
responsible for paying the employee portion of the FICA tax.
The employer must pay the employee’s share of the FICA
taxes, but the value of the tax paid must be added to the employee’s
wages using the gross-up method. (The gross-up method is described
in IRS Publication 15-A on page 19 under the heading of “Employee’s
Portion of Taxes Paid by Employer.”)
In addition to calculating the value of the benefit, an employer
must be able to correctly report the value of the benefit. The
value 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 value 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
value 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 value of
the GTL, so employers must also include the value 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 value 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 Value of the employee's coverage as
follows:
- Calculate the value of excess insurance. ($100,000 - $50,000
= $50,000)
- Divide the excess value 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 paid 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 assume 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 employer calculates 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 responsible for paying the FICA
taxes, the employer must gross up the value 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 employer may continue to provide GTL to former
employees (including retirees). If that is the case, the former
employee is still responsible for paying the FICA taxes, but
since the individual is no longer actively employed, the employer
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 value of excess insurance. ($120,000 - $50,000
= $70,000)
- Divide the excess value 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 employers 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 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, Employer’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 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.
**Robert W. Ditmer, CPP, is Controller of the University and Whist Club of Wilmington, Delaware, a private member dining club and catering facility. Although currently a resident of the State of Delaware, he spent 24 years in Philadelphia, Pennsylvania, dealing with Pennsylvania taxes and multi-state taxation for states with reciprocal agreements with Pennsylvania. He can be reached at robertwditmer@yahoo.com.
