IRS Revises Group Term Life Coverage Tax Table - Brief Article

Healthcare Financial Management, Feb, 2000 by Brian J. Malynn, Randall W. Luecke

On July 1, 1999, a revision of the rates used by the IRS to calculate the taxable portion of group term life insurance, known as imputed income, took effect. The new rates offer healthcare financial managers an opportunity to lower imputed, or taxable, incomes for employees. In addition, implementing the new rates can disclose incorrect methods of calculating imputed income and improperly completed employee W-2 forms.

The IRS recently revised the rates it uses to calculate the taxable portion of group term life insurance. The revision of these rates has implications for healthcare organizations that offer their employees group term life insurance. The new rates took effect on July 1, 1999.

Section 79 of the Internal Revenue Code (IRC) allows the value of the first $50,000 of employer-provided group term life insurance coverage to be excluded from the gross income of employees. The value of employer-provided coverage in excess of $50,000 is included in the gross income of employees. The taxable value of employer-provided group term life insurance is called "imputed income" because, even though the employees do not receive cash, they are taxed as if they had received cash in an amount equal to the taxable value of their coverage. Generally, the imputed value of employer-provided group term life insurance is determined by multiplying the amount of coverage in excess of $50,000 by an age-related valuation rate. It is these valuation rates, which appear in IRS Table I, "Uniform Premiums for $1,000 of Group-Term Life Insurance Protection," that have been adjusted.

Exhibit 1 compares the former IRS Table I with the revised Table I. The ages in each table represent the insured person's age as of the last day of the calendar year. For example, for a person who reaches age 55 in December, the 55-59 rate band is used for the entire year. The new Table I adds a five-year age bracket for employees under age 25 and significantly reduces rates for all age groups. The new age bracket is in effect as of January 1, 2000. Employers were given until the end of 1999 to modify their payroll systems to account for the new age bracket.

The imputed income rules do not apply to employee-pay-all plans in which all premiums are paid with after-tax contributions at, or less than, the Table I rate. To determine whether the imputed income rules apply to such plans, in existence as of June 30, 1999, employers may use the old Table I rates until January 1, 2003.

Calculating Imputed Income

If the employer-provided group term life insurance coverage is more than $50,000, the amount of imputed income will depend upon the amount of the excess coverage over $50,000 and whether the employee contributed after-tax dollars toward the coverage.

The imputed income calculation includes only full months of coverage (ie, employees hired after the first of the month are not charged until the first of the following month). Plans can be designed to use either a "frozen" coverage amount established at the beginning of the plan year or a dynamic coverage amount that changes during the course of the year. Using the frozen coverage approach simplifies the imputed income tax calculation.

The following examples, based on the new Table I rates, illustrate how imputed income is calculated for common plan designs. The examples are organized into five groups:

* Contributory basic coverage with pretax employee contributions;

* Contributory basic coverage with after-tax employee contributions;

* Noncontributory basic coverage;

* Noncontributory basic coverage with employee-pay-all supplemental coverage (pretax); and

* Noncontributory basic coverage with employee-pay-all supplemental coverage (after-tax).

In these examples, imputed income is reported on a per-pay-period basis. Although the IRS permits annual withholding, healthcare organizations that do so risk underwithholding FICA tax for the year for employees who terminate during the year.

Contributory basic coverage with pretax employee contributions. In a contributory basic plan in which coverage is provided under a single group insurance contract and employees pay a portion of the cost for the coverage with pretax dollars, the imputed income is calculated as follows:

Step 1 Subtract $50,000 from the amount of basic life coverage.

Step 2 Divide the amount determined in Step 1 by 1,000 and then multiply by the Table I rate. The result is the monthly imputed income.

Example: A hospital provides a group term life program with a basic benefit formula of two-times salary, rounded up to the nearest $1,000. Employees pay $0.03 per $1,000 of coverage per month in pretax dollars for coverage in excess of $50,000. The hospital pays the remaining cost of the coverage. Imputed income for a 31-year-old employee who earns $35,000 per year is calculated as follows:

Step 1 $70,000 - $50,000 = $20,000

Step 2 $20,000 $1,000 x $0.08 = $1.60 per month

Contributory basic coverage with after-tax employee contributions. When basic coverage is provided under a single group insurance contract and employees pay a portion of its cost with after-tax dollars, the imputed income is calculated as follows: