Understanding Employer-Sponsored Insurance Tax Implications
This article provides summary information about three “imputed income” areas you might want to review with your Payroll provider, Tax or Accounting Department, or outside CPA to see if you need to make any adjustments to your tax withholding amounts for 2016 W-2s or modify your procedures for 2017.
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 dollar value of certain benefits provided is considered “imputed income” to the employee and thus is included as taxable income to the employee. This article explains the following three situations in which certain employer-provided benefits are or may be taxable to employees:
- Certain long-term disability (LTD) “gross up” insurance plans.
- Several circumstances under which the cost of group term life insurance is imputed income to employees
- Benefits provided to certain categories of individuals who do not meet federal tax law definitions of “dependent” – such as “registered domestic partners”
Group Health Plan Coverage for Domestic Partners and Their Children
The issue: You may have to impute income for federal tax purposes, even though not for California state tax purposes, for individuals who are “registered domestic partners” under California law but who are not “Tax Code dependents” under federal law.
Additionally, if an employee claims an individual as his or her “Domestic Partner” but the employee and individual are not “registered” Domestic Partners, employer contributions toward group health coverage for this person will be subject to both California and federal tax withholding, unless the employee certifies that this non-registered domestic partner meets the Tax Code definition of “qualifying relative.” This same taxation applies to any employee pre-tax contributions for a non-registered domestic partner’s coverage. (Non- registered “domestic partners” are often opposite-sex partners.)
Note that the tax implications now are different for same-sex spouses than for domestic partners. Until recently, this was not the case. Prior to Obergefell v Hodges (USSC 2015), the cost of coverage for same-sex spouses also was imputed income to employees unless the spouse 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 issue: You must impute income for life insurance coverage above $50,000 if the policy is carried directly or indirectly by the employer; for coverage of any amount for “key employees” provided through a discriminatory plan; 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
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. Below is Table 1. Cost per $1,000 of group term life insurance (from IRS Pub. 16-B (2016), 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). The situation that should be remedied immediately is where 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.
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 ($170,000 in 2016) 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.
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” Plans
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.
FAQ: Imputed Income and Related Tax Matters
Q1: What is imputed income? A: Imputed income refers to the value of any non-cash benefit or service provided by an employer that must be considered as part of an employee’s taxable income. Common examples include certain employer-provided life insurance, long-term disability benefits, and health coverage for domestic partners that do not qualify as tax dependents.
Q2: How does imputed income affect my taxes? A: Imputed income increases your taxable income, which could potentially place you in a higher tax bracket, resulting in more taxes owed. It’s important to review your benefits and understand which are considered imputed income to accurately calculate your tax liabilities.
Q3: Are there any exceptions to what is considered imputed income? A: Yes, there are exceptions. For example, employer contributions towards certain retirement plans, health insurance for employees and their dependents, and certain educational assistance benefits may not be considered imputed income. It’s crucial to consult with a tax professional for specific cases.
Q4: What is the significance of the $50,000 threshold in group term life insurance? A: For employer-provided group term life insurance, the cost of coverage up to $50,000 is generally not considered imputed income and is tax-free. However, coverage exceeding this amount is usually considered imputed income and is taxable.
Q5: How is the imputed income for group term life insurance calculated? A: The imputed income for group term life insurance over $50,000 is calculated based on IRS Table I rates, which consider the employee’s age and the amount of insurance. These rates are available on the IRS website.
Q6: What are long-term disability (LTD) “gross-up” plans, and how do they impact taxes? A: LTD “gross-up” plans are arrangements where an employer pays the premiums for long-term disability insurance but includes the premium amount as taxable income to the employee. This setup ensures that if the employee receives disability benefits in the future, those benefits are not taxable since the premiums were paid with after-tax dollars.
Q7: What tax implications are there for domestic partner benefits? A: If an employer provides benefits to a domestic partner who doesn’t qualify as a tax-dependent, the value of these benefits is considered imputed income and is taxable. However, if the partner qualifies as a dependent under tax law, the benefits may not be taxable.
Q8: Can imputed income vary based on state laws? A: Yes, while federal tax laws apply nationwide, state tax laws can differ. For instance, some states may not tax certain benefits that are considered imputed income at the federal level. It’s important to understand both state and federal tax implications.
Q9: Are there ways to reduce the impact of imputed income on my taxes? A: One approach is to opt for benefits that are not considered imputed income, when possible. Additionally, increasing your tax deductions and contributions to tax-advantaged accounts like 401(k)s or IRAs can help offset the tax impact. Consulting a tax advisor for personalized strategies is advisable.
Q10: Where can I find more information about my specific imputed income situation? A: For detailed and personalized advice, it’s best to consult with a tax professional or a CPA. You can also refer to IRS publications and your employer’s human resources department for general information.