Abstract: Employer-provided life insurance can be a great benefit, with the cost of
part of it excluded from an employee’s taxable income. Participating employees
need to be aware that this exclusion only applies to the first $50,000 in
coverage, and the employer-paid cost of the excess will be reported on the
employee’s Form W-2. This is true even if the life insurance is never received.
A sidebar reveals how the value of that taxable income is determined.
When is employer-provided
life insurance taxable?
If
your company benefits include group term life insurance paid by your employer,
a portion of the premiums paid for the coverage may be taxable. Depending on
the amount of coverage you’re provided, some of it may create undesirable
income tax consequences for you.
The
cost of the first $50,000 of group term life insurance coverage that your
employer pays for is excluded from taxable income and doesn't add anything to
your income tax bill. That’s good news. But the employer-paid cost of group
term coverage over $50,000 is taxable income to you. That means it will be
included in the taxable wages reported on your Form W-2 — even if you never
actually receive it. In other words, it’s “phantom income.”
Have you reviewed your W-2?
What
should you do if you think the tax cost of employer-provided group term life
insurance is too high? First, you should establish if this is actually the
case. If a specific dollar amount appears in Box 12 of your Form W-2 (with code
“C”), that dollar amount represents your employer’s cost to provide you with
group-term life insurance coverage of more than $50,000, minus any amount you
paid for the coverage. You’re responsible for federal, state and local taxes on
the amount that appears in Box 12 and for the associated Social Security and
Medicare taxes as well.
But
keep in mind that the amount in Box 12 is already included as part of your
total “Wages, tips and other compensation” in Box 1 of the W-2. It’s the amount in Box 1 that is reported on
your tax return.
What
are your options?
If
you decide that the tax cost is too high for the benefit you're getting in
return, you should find out whether your employer has a “carve-out” plan.
That’s a plan that allows selected employees to carve out from the group term
coverage. If your employer’s plan doesn’t offer a carve-out, ask if they’d be
willing to create one.
There
are several different types of carve-out plans that employers can offer to
their employees. For example, the employer can continue to provide $50,000 of
group term insurance (since there's no tax cost for the first $50,000 of
coverage). Then, the employer can either provide the employee with an
individual policy for the balance of the coverage or give the employee the
amount the employer would have spent for the excess coverage as a cash bonus
that the employee can use to pay the premiums on an individual policy.
You
may have questions about this important topic, such as how much your group term
life insurance benefit is adding to your income. Contact us for help with this
and other questions.
Sidebar
How is phantom income calculated?
The cost of employer-provided group term life
insurance that will be taxable income to you is determined using the IRS
Premium Table based on preset factors such as age. Under these determinations, the
amount of taxable phantom income attributed to an older employee is often
higher than the premium the employee would pay for comparable coverage under an
individual term policy. This tax trap gets worse as the employee gets older and
as the amount of his or her compensation increases.
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