Intro

Section 79 and the potential challenges facing employers regarding the structure of their employee benefit plans. Without a properly
structured plan, employees may be responsible for paying federal taxes on imputed income, and employers may be faced with substantial additional administrative work and costs in calculating imputed income.
IRS regulations require that imputed income be reported as it is incurred through the year. Therefore, it must be incorporated in payroll during the course of the year. Imputed income may not simply be included in the year-end W-2. Imputed income is also subject to regular payroll taxes including FICA. Many large employers offer a group life insurance plan to employees that include basic and voluntary life insurance on employees and voluntary life insurance on dependents.

It is common knowledge that ‘imputed income’ under Section 79 of the Internal Revenue Code must be calculated on employer-paid basic life insurance in excess of $50,000. However, employers
may not know that under certain circumstances, imputed income calculations must also consider voluntary life insurance on employees. Employers also may not realize that under certain circumstances imputed income must be calculated for voluntary
life insurance on dependents. For the reasons outlined previously, most employers do not wish to calculate imputed income on voluntary life insurance on employees or dependents and careful forward planning is therefore essential.


Basic Requirements

Section 79 of the Internal Revenue Code (IRC) governs imputed income on group term life insurance for employees. Section 61 of the Code governs the taxation of life insurance on dependents. We will first address the Section 79 employee life concerns and
then the Section 61 dependent life concerns. Section 79 details the tax implications for employer sponsored group term life insurance. It does not apply to employer-sponsored whole life insurance or
accidental death and dismemberment coverage. The following situations involving employer-sponsored group term life insurance may have tax consequences:

• Employer-paid group term life benefits that exceed $50,000.
• Discriminatory employer-paid term life plans.
• Employer-sponsored voluntary life coverage.
• Employer-sponsored voluntary life insurance paid for with pretax dollars under a Section 125 plan.

In order to qualify for the Section 79 tax exclusion, a life insurance plan must meet all of the following requirements:

• The plan must provide life insurance benefits that are excludable from beneficiaries’ income under IRC Section 101(a). (IRC Section
101(a) provides that life insurance benefits are excluded if paid because of death; this encompasses term life products, including those with viatical benefits).

• The life insurance must be term coverage. Plans cannot take advantage of Section 79 to the extent that they provide permanent
benefits – such as a cash surrender value – to employees. The IRS has said, however, that individual policies providing permanent benefits
may qualify as group-term life insurance that is subject to Section 79. If such a policy is subject to an agreement between the insured employee and the employer under which the only benefit that the employee receives under the policy is life insurance coverage, the coverage provided to the employee may be subject to Section 79.

• The plan must cover a group of employees or former employees. The plan may be set up for a limited group of employees (such
as those covered by a collective-bargaining agreement), but eligibility criteria are subject to the nondiscrimination rules. Special rules apply to groups of less than 10 employees. In addition,
it is possible to create a ‘group’ arrangement by purchasing individual policies for employees.

The coverage must be provided under ‘a policy carried directly or indirectly’ by the employer. Section 79 defines ‘group of employees’ as:

• All employees or a controlled group of employees.
• Employees considered to be in a covered group because of one of the following factors:
• Age (subject to ADEA requirements).
• Employment-related factors, including union membership, job duties, length of employment, compensation or participation
in a company retirement, stock bonus or group insurance plan.

If an employee is eligible for benefits under more than one group-term life plan, the coverages generally are aggregated for purposes of the Section 79 exclusion. This means that an individual employee generally can exclude only the cost of $50,000 in coverage regardless of the number of plans providing the
coverage.

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