As 2018 draws to a close, one end-of-year action item for employers is to make sure you are correctly characterizing and taxing any “imputed income” your employees may have. You still have time to make any corrections (if needed) for 2018 Form W-2s, and to set up your payroll and tax system correctly for 2019. This article provides summary information about three benefits-related “imputed income” areas:
- Benefits for domestic partners and other individuals who do not meet federal tax law definitions of “dependent”
- Cost of group term life insurance – in certain situations
- Long-term disability (LTD) “gross up” amounts
What is Imputed Income?
Generally, employees are not taxed on the value of employer-provided benefits for the employee and his or her dependents. There are important exceptions to this rule, however, where the cost or fair market value of certain benefits provided is considered “imputed income” to the employee and thus is included as taxable income to the employee. Ideally, imputed income amounts should have been taxed as such over the course of the year, but if they were not, at least these amounts should be included as such on employees’ W-2s. This article explains the three situations listed above, in which certain employer-provided benefits are or may be taxable to employees.
Group Health Plan Coverage for Domestic Partners and their Children
The issue: You may have to impute income for federal (and most state) tax purposes, for employees who cover their domestic partners who do not qualify as “Tax Code dependents” under federal law. For California state tax purposes, however, do not impute income for the benefits for California “registered domestic partners.”
This is a confusing area, so talk with your payroll provider and tax adviser, and make sure your payroll system is properly set up. Here are a few bullet points that might help:
- If a domestic partner is not a Tax Code dependent and is enrolled in your employer group benefit plan(s), you should impute income to the employee, equal to the fair market value of any coverage provided that is paid for by the employer, or by the employee on a pre-tax basis. There is no imputed income on amounts that are paid by the employee on an after-tax basis.
- The IRS does not explicitly define “fair market value,” but most employers use the cost of self-only or spouse-only coverage.
- If a domestic partner qualifies as a Tax Code dependent, there is no imputed income. You can rely on an employee’s signed Affidavit as to whether or not a domestic partner qualifies as a Tax Code dependent. That means you do not have to impute income and withhold taxes, but if it turns out the domestic partner was not a Tax Code dependent, the IRS could later require the employee to pay taxes on the imputed income amount (but the employer would not be penalized).
- There is a difference between “domestic partners” and “California registered domestic partners,” but only for purposes of California state tax withholding. Both categories of domestic partners are treated the same for purposes of federal tax withholding (the first two bullet points above).
- Each employer can define who qualifies as a non-registered domestic partner for purposes of eligibility for employer group benefits. Many employers define domestic partners to include opposite-sex partners as well as same-sex partners. California registered domestic partners are almost always same-sex partners, although the law also allows registration of opposite-sex partners if one partner is at least age 62 and meets the requirements of California Family Code section 297.
Note that the tax implications are different for same-sex spouses than for domestic partners. For both federal and state tax withholding, “spouse” includes both opposite-sex and same-sex spouses. Prior to Obergefell v Hodges (USSC 2015), this was not the case, and the fair market value of coverage for both same-sex spouses and domestic partners was imputed income to employees unless the spouse or partner qualified as a Tax Code dependent. In Obergefell, the US Supreme Court held (5-4) that the fundamental right to marry is guaranteed to same-sex couples by both the Due Process Clause and the Equal Protection Clause of the Fourteenth Amendment to the Constitution.
Group Term Life Insurance for Employees
The issues: You must impute income for: 1) life insurance coverage above $50,000 if the policy is carried directly or indirectly by the employer; 2) coverage of any amount for “key employees” provided through a discriminatory plan; 3) employer-paid coverage in excess of $2,000 for spouses or dependents.
For additional information on imputed income for group term life insurance, see https://www.irs.gov/government-entities/federal-state-local-governments/group-term-life-insurance
1) Coverage in excess of $50,000. All participants (both “highly compensated” and non-highly compensated) will have imputed income on premiums for group term life insurance in excess of $50,000, if the policy is carried directly or indirectly by the employer. A policy is considered to be carried by the employer if:
- the employer pays any part of the premiums (this includes premiums paid on a pre-tax basis by employees, through a cafeteria plan), or
- the employer arranges for the premium payments and the premiums paid by at least one employee subsidize those paid by at least one other employee. This situation is called “straddling” the IRS Table 1 rates, as explained below. There are a few exceptions, when coverage in excess of $50,000 will not be taxable to the covered employee: 1) coverage provided after an employee becomes disabled; 2) any portion of coverage for which the employer is directly or indirectly the beneficiary; and 3) coverage for which a charity is the sole beneficiary.
If the premiums for coverage in excess of $50,000 are taxable, the imputed income amount is based on the IRS Table I rates rather than on the rates employees actually pay.
The plan “straddles” the Table I rates. If an employer offers employee-paid supplemental group term life insurance and arranges for the premium rates, employees who pay less than the Table 1 rates will have imputed income for insurance in excess of $50,000. The imputed income amount will be equal to the difference between the Table I rates and the amounts they pay. This is the case even though the employees are paying the entire premium with after-tax dollars. Employees who pay more than the Table I rates will not have imputed income.
Why does “straddling” occur? This situation often results because the employer charges older (and usually higher-paid) employees less than the Table I rates, while charging younger (usually lower-paid) employees more than the Table I rates, resulting in the younger employees “subsidizing” the rates paid by older employees. That’s why the rules require imputed income in this case.
Below is Table 1. Cost per $1,000 of group term life insurance (from IRS Pub. 15-B (2017), page 13, https://www.irs.gov/pub/irs-pdf/p15b.pdf ).
|Age||Cost per $1,000|
|25 through 29||$0.06|
|30 through 34||$0.08|
|35 through 39||$0.09|
|40 through 44||$0.10|
|45 through 49||$0.15|
|50 through 54||$0.23|
|55 through 59||$0.43|
|60 through 64||$0.66|
|65 through 69||$1.27|
|70 and older||$2.06|
Sometimes an employer’s rates violate this rule by only a few cents (or less) per $1000 in one or two age bands, and this is easily remedied by re-structuring the rates so there is no “straddling” (i.e., so all employees’ rates are either higher than, the same as, or lower than the Table I rates for their age brackets).
2) Discriminatory plan. If your group term life insurance plan discriminates in favor of any “key employee”— either as to eligibility or as to the kind or amount of benefits—then all “key employees” covered under the plan must include in taxable income the cost of the first $50,000 of coverage. The amount taxable to the key employees is the higher of actual cost or Table I cost. There are no tax consequences to non-key employees in the plan.
Under Tax Code section 416(i)(1)(A) and regulations, a key employee is one who is either:
- An officer of the company with gross pay in excess of $175,000 in 2017 or 2018, or
- An employee of the company in the current year who:
- Owns 5% or more of the company in the current or previous year, or
- Owns more than 1% of the company in the current or previous year and had gross compensation in the previous year of more than $150,000.
- Note that family stock attribution rules apply in determining 5% and 1% ownership.
3) Coverage in excess of $2,000 for spouses or dependents. If the employer pays the premium for life insurance with a face amount of more than $2,000 for an employee’s spouse or dependents, the entire premium amount is imputed income for the employee. If the life insurance is less than $2,000, however, the coverage is excludable as a “de minimis” fringe benefit under IRC Section 132, and there is no imputed income for the employee. See IRS Notice 89-110 for more information.
Long-Term Disability “Gross-Up” Plan
The issue: Employers who pay the premiums for employees’ long-term disability (LTD) insurance may want to impute income equal to the premium amount, so the premium will be paid by employee after-tax dollars and benefits will not be taxable if an employee becomes disabled.
If LTD premiums are paid with after-tax employee dollars, any benefits received will not be subject to taxation. In contrast, benefits are included in taxable income to the extent they are attributable to premiums paid by the employer or paid with employee pre-tax dollars. Some employers offer arrangements under which employees can elect annually whether they or the employer will pay their LTD premiums for the upcoming year. Other employers pay the LTD premium and then impute income only for certain categories of employees (often management employees). You must discuss with your carrier how premiums will be paid before you implement such arrangements.
Another factor that might influence whether an employer pays the premium and imputes income to employees is the effect of such an arrangement under the Affordable Care Act (ACA) “Employer Shared Responsibility” provisions that apply to “applicable large employers” (i.e., those who employed on average at least 50 full-time employees and “full-time equivalents” in the prior calendar year). Employers must count “hours of service” to determine if a particular employee is full-time or not. Hours of service include all hours for which an employee is paid or entitled to payment, plus hours of “special unpaid leave.” Hours that must be counted include hours for which an employee receives insured disability benefits IF the employer paid the premiums, but NOT if the employee paid the premiums with after-tax dollars.