Imputed income is the cash value of the non-cash benefits employees receive from their employers. Employees may not think of these non-cash benefits as income, but like salaries and wages, imputed income must be reported to the Internal Revenue Service (IRS).
Employers offer many types of non-cash compensation that count toward employees’ taxable income, including group-term life insurance coverage. However, while many employers have continued to expand their benefits, how they will affect your tax status varies depending on a variety of factors. Read on to learn more about how imputed income may affect you and your family.
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Understand Your Employer-sponsored Benefits
Employer-sponsored life insurance is a common feature in employee benefits packages. Employers set up the policy and offer coverage to a group of employees. Often, they pay premiums on behalf of their covered employees.
When the cost of this benefit reaches a certain level, the IRS assigns it a cash value and treats it as ordinary income. The purpose of group term life imputed income is to ensure employees and their employers pay their fair share of taxes on all sources of income.
How Imputed Income Works With Life Insurance
Employees may not think of their life insurance coverage as income, but this employer-provided benefit has a cash-equivalent value to the IRS. Imputed income is the assumed value given to this coverage.
Eligibility
For group term life insurance policies, the cost of the first $50,000 in coverage is excluded from income. Any excess coverage beyond $50,000 is assigned a monetary value based on the IRS’ life insurance cost tables. This value counts toward the employees’ incomes.
Imputed Income On Life Insurance With Cash Value
Some employer-sponsored life insurance plans offer permanent benefits, such as a cash surrender value. The cost of this coverage, minus the amount the employee paid toward their coverage, is also subject to tax.
Employers are responsible for calculating the cost of permanent benefits. This calculation is based on the death benefit, premium costs, and mortality tables. If the policy pays dividends, these amounts may also be included in employees’ incomes and are taxed accordingly.
Other Sources of Imputed Income
Group term life insurance is not the only fringe benefit that’s treated as taxable income. Other sources of imputed income include:
- Key person life insurance: In life insurance plans that favor key employees, key employees pay tax on the entire cost of their group life insurance.
- Company-owned life insurance: For these plans, the amount excluded from the employee’s income cannot be more than what they paid for the coverage.
- Education assistance: If employers provide tuition benefits and other education assistance, annual amounts above $5,250 are subject to tax.
- Transportation benefits: Personal use of a company car is treated as income. If an employer pays for transit passes or parking fees, monthly amounts above $300 are taxable.
How to Calculate Your Life Insurance Imputed Income
Employers are responsible for calculating their employees’ group term life imputed income and reporting it on their W-2 forms. This calculation is based on:
- Employee age: The cost of providing term life insurance coverage increases with age, which is reflected in employees’ imputed income.
- Tax rate: Each age range corresponds to a group term life insurance tax rate, which is set by the IRS.
- Policy type: The cost of insurance is calculated differently for some types of employer-provided coverage, such as plans that favor key employees.
To calculate group term life imputed income at a glance, check this insurance cost chart from the IRS.
Age Range | Cost Per Month Per $1,000 of Coverage |
|---|---|
Under 25 | $0.05 |
25-29 | $0.06 |
30-34 | $0.08 |
35-39 | $0.09 |
40-44 | $0.10 |
45-49 | $0.15 |
50-54 | $0.23 |
55-59 | $0.43 |
60-64 | $0.66 |
65-69 | $1.27 |
70 and Older | $2.06 |
Basic Group Term Life Insurance
Basic group term life insurance is a common component in employee benefits packages. This coverage is typically offered to employees for free or at a nominal cost without needing a medical exam. Some companies cover all employees at a set amount, such as $25,000, while others offer one or twice employee salaries.
The group term life insurance tax applies to coverage that exceeds $50,000 when the employer directly or indirectly carries the policy. This means the employer either pays some or all of the premium costs or redistributes the cost of employee-paid premiums.
Voluntary Life Insurance
Voluntary life insurance is an optional benefit that supplements an employer’s basic term life insurance policy. Employees who enroll in this coverage pay monthly premiums, typically through convenient payroll deductions.
Voluntary life insurance policies not carried directly or indirectly by the employer are not subject to the group term life insurance tax. Policies fit this requirement if employees pay their own premiums and the employer does not subsidize or redistribute premium costs.
How to Report Your Imputed Income
Taxable imputed income must be reported to the IRS on the tax forms that apply to each employee’s situation. Some forms you may receive from your employer or be responsible for completing include:
- Form W-2 Wage and Tax Statement: Employers are required to report the value of the fringe benefits they provide on their employees’ W-2s. Imputed income for group term life insurance is reported in box 12 with code C.
- Form 1040 U.S. Individual Income Tax Return: Employees use the information on their W-2s to complete their annual income tax return.
- Form 6251 Alternative Minimum Tax — Individuals: Some employees with higher incomes are required to complete this form.
- Form 709 Gift Tax Return: If an employee transfers the benefits of their life insurance policy to a charity, the gift tax may apply.
Consequences of Not Correctly Reporting Income
The IRS applies penalties to taxpayers who do not file accurate returns, including underreporting their income. These penalties range from fines to criminal charges, depending on the amount of the underreporting and the taxpayer’s intent.
Otherwise, honest taxpayers may forget to report income that was listed on their W-2. For errors due to negligence, the IRS charges a penalty of 20% of the underpaid tax amount. For example, if the IRS determines a taxpayer underpaid by $500 due to negligence, the penalty is $100.
The consequences of deliberately underreporting income are higher. The civil fraud penalty is 75% of the underpayment of tax, and criminal tax evasion is punishable by up to 5 years in prison.
Exceptions and Exemptions for Imputed Income on Life Insurance
There are some situations when some or all of the cost of group term life insurance does not count toward an employee’s gross income. Some key exceptions and exemptions include:
- Employee coverage of $50,000 or less: The IRS excludes the cost of the first $50,000 of term life insurance coverage.
- Dependent coverage of $2,000 or less: These low-value policies for spouses or children are considered de minimus (minimal) benefits, which means they’re too minor to be worth accounting for.
- Coverage for some former employees: The full cost of group term life insurance is excluded for certain employees who left their jobs after becoming disabled and employees who retired before 1984.
- Policies that pay proceeds to a charity: When an employee names a charitable organization as their sole beneficiary, the cost of the policy is excluded from income.
How to Avoid Imputed Income On Your Group Term Life Insurance
Consumers who prefer to avoid the tax implications of group term life insurance have several options. Potential solutions include:
- Waiving the coverage: Some employees decline their employer’s basic life insurance policy for tax reasons. However, if they change their minds, it may not be possible to get this coverage later.
- Donating the proceeds to charity: The group term life insurance tax does not apply if a charitable organization is named as the sole beneficiary.
- Working with a tax professional: A tax specialist who understands your individual situation may recommend additional strategies.
Putting It All Together
Group term life insurance is often provided at no or low cost to employees, though the value of this coverage can become apparent at tax time. Employees pay group term life insurance tax if their policy’s face value exceeds the IRS’ $50,000 exclusion.
Talk to a trusted tax professional if you’re concerned about the tax implications of your employer’s group life insurance policy or need help accurately reporting this income.