If you are an employee and you have more than $50,000 in your group life insurance policy through your workplace, then you might have to pay taxes on any amount that is more than $50,000. This is the rule under the federal law.
If you do have this much in insurance or more, then your employer might have to impute the income to you as the employee. To cover this requirement, some employers might impute the income on the insurance coverage as they give it to you over the year.
But other employers might wait until the year is over to do this. It is recommended that the employers track the value of the insurance throughout the year. However, either method is allowed under the law as long as the employer does this required imputing by the time the year is over.
What Is Life Insurance?
This policy is a contract with an insurance company. Either you or your employer will make regular payments, which are known as the premiums. You will then get a death benefit once the insured person dies.
Often, the policy is chosen based on the goals and the needs of the policyholder. For example, you might have term life insurance through your employer. What this does is provide protection for a certain amount of time.
On the other hand, a permanent insurance policy, like universal or whole life, offers coverage for the rest of your life. Remember that the death benefits that you will receive are often free of taxes.
Usually, getting a policy ensures that you get financial support for your family or dependents. But you can also have other beneficiaries on the policy. Some people might want to look into life insurance.
For example, if you have minor children, then there might be a loss of income. Or the child may no longer benefit from the parent’s caregiving skills. That might create financial difficulties. By getting life insurance, you can ensure that your children will have enough financial resources until they are able to become financially independent.
If you have special-needs children that are adults, you may also want to consider getting this kind of insurance. They may need care for the rest of their lives, even after you pass away. With the death benefit from their insurance, you can ensure that you are able to fund them and have someone manage a trust for them.
If you own property with another adult, you might also want to consider this kind of insurance. Whether or not you are married to the other property owner, if one of the adults were to pass away, then the other might not be able to afford the taxes, loan payments, or maintenance on that property.
Life insurance might be a good idea in this case. For example, that might include a couple that decided to get a mortgage to get their first home together.
Sometimes, elderly parents might want to give money to their grown children that offer them care. In many cases, the adult children might sacrifice by offering their valuable time to take care of their elderly parents.
That might include taking the parents to appointments. Or they may give their parents financial support. With life insurance, it is possible to reimburse the adult child once both of the parents have passed away.
Why This Matters
It is important to recognize your imputed income because this is considered to be a fringe benefit. This refers to a benefit, like an experience, service, or good, that your employer offers to you along with your regular salary.
When it comes to group life insurance, the IRS says that getting life insurance of more than $50,000 is considered to be a fringe benefit. That means that it is a taxable form of income for you.
For employers, it is important to note imputed income life insurance because that has to go in the W-2 tax forms for each of the employees. Employers need to report this because if they do not, then they might accidentally undervalue how much in taxes each employee has to pay.
Some Background on Imputed Income
According to the federal tax code, the first $50,000 in your group life insurance coverage is excluded when your employer offers it to you. So, if you have a policy that is less than this amount, you likely do not have much to worry about.
However, there is no exclusion in the tax code for extra insurance that your employer provides to you. What this means is that anything greater than $50,000 is subject to federal income taxes. Plus, it is subject to Medicare and Social Security taxes.
The amount of excess coverage that your employer offers to you needs to be reported on your W-2. They need to withhold your portion of the Medicare and Social Security taxes. Plus, the employer needs to pay their portion of these two types of taxes.
Remember, that in some cases, you might be able to avoid this imputing requirement if the rates you pay in premiums for the group term insurance meet some requirements. You can talk to your employer about whether or not your specific insurance policies meet these requirements.
Provided by the Employee and Paid for by the Employer
If you pay the entire premium for your life insurance, you might automatically assume that you do not get the coverage provided by your employer. However, when it comes to group term coverage, that might not be the case in all instances.
If your employee pays for your coverage using dollars that have not been taxed, then for tax purposes, your coverage might be treated like the employer has paid for the premiums. Plus, even if you pay your premium with dollars that have already been taxed, your coverage might be considered to be provided by your employer.
This might happen if the cost of your coverage is more than the premium that the insurance company is charging.
How the IRS Determines the Price of Getting Group Term Insurance
The IRS’s regulations have a list of rates that you can use to calculate the cost of the extra insurance coverage you are getting and how much you will need to pay in taxes. According to these Table I rates, they are not changed when inflation takes place.
This means that they will not change throughout the year. They will only change when the IRS decides to change the regulations. Just remember that you will need to check their website to get the most updated information.
You should also remember that the rates that the IRS determines might be lower or higher than the premiums that you actually pay to get your group term insurance. If the rates from the IRS are higher, then you might have extra taxable income.
This might happen even if you paid all of the premiums for your extra coverage with your after-tax dollars. This is because of the extra coverage you have, which is determined by the IRS.
Determining How Much Income to Impute
If your employer pays all of your premiums for your group life insurance, then it is easy for you to determine how much you should impute. Just take away $50,000 from your total life insurance coverage that you have for that year.
Then multiply the rest of that amount by the right rate found in Table I. If your employer does not pay the premiums, but your payments are done before taxes, then the same thing will apply.
If you pay part or all of this premium for any type of life insurance, such as the first $50,000 of it, with after-tax dollars, you will need to do some more math. Once you have found the right Table I cost for the coverage that is more than $50,000, you will subtract the amount of your after-tax contributions toward your coverage.
That includes any contributions that are for coverage of less than $50,000. If you get a positive number, then this is the amount you should impute.
If you have more than one term life insurance plan that is covering you, then according to the IRS, you need to aggregate the coverage so that you can’t exclude the amount of $50,000 or more in your coverage for that year.
About Dependent Life Insurance
You might have dependent insurance that is provided by your employer. This is taxable unless the insurance you have is no more than $2,000. If you have more than $2,000 in your coverage, then all of that insurance is taxable. That includes the first $2,000 of that.
If you have a lot of coverage from your employer, then you should plan on imputed income. Talk to your employer if you are not certain about whether or not you need to pay income taxes on your insurance. Knowing more about this can help you to make more informed decisions.