How Is the Cost of Life Insurance Over $50,000 Taxed?

Group-term life insurance is a common employer-offered benefit. Under federal tax law, the cost to provide the first $50,000 of this coverage is a tax-free fringe benefit, meaning employees pay no tax on this initial amount. However, any coverage an employer provides above the $50,000 threshold has tax implications. The value of this excess coverage is considered taxable income by the Internal Revenue Service (IRS), and understanding how it is calculated is important for managing personal tax obligations.

Calculating the Taxable Value of Excess Coverage

The taxable amount from life insurance over $50,000 is not based on the premium the employer pays. Instead, the IRS determines this value, known as “imputed income,” using a specific formula and a standardized rate chart. This process ensures a uniform method for valuing the benefit across all employers.

The IRS provides a cost table in Publication 15-B, Employer’s Tax Guide to Fringe Benefits, that dictates the monthly cost for every $1,000 of insurance based on an employee’s age. The rates are:

• Under 25: $0.05
• 25-29: $0.06
• 30-34: $0.08
• 35-39: $0.09
• 40-44: $0.10
• 45-49: $0.15
• 50-54: $0.23
• 55-59: $0.43
• 60-64: $0.66
• 65-69: $1.27
• 70 and over: $2.06

To illustrate the calculation, consider a 42-year-old employee who receives $150,000 in group-term life insurance. The first step is to determine the excess coverage by subtracting the $50,000 exclusion from the total, which results in $100,000 of taxable coverage. Next, this excess amount is converted into 100 units of $1,000 ($100,000 / 1,000).

The employee’s age on the last day of the tax year determines the rate. For the 42-year-old, the rate is $0.10 per month for each $1,000 of coverage. Multiplying the 100 units by this rate gives a monthly taxable value of $10.00. The total annual imputed income is $120 ($10.00 12), and this is the figure that must be reported for tax purposes.

Tax Reporting and Withholding

After calculating the annual taxable value, the employer must report it correctly on the employee’s Form W-2, Wage and Tax Statement. This imputed income is identified in Box 12 of the W-2 with the code “C”.

The amount shown in Box 12 with code “C” is also included in the employee’s total taxable wages. This figure is factored into the totals reported in Box 1 (Wages, tips, other compensation), Box 3 (Social Security wages), and Box 5 (Medicare wages).

The value of the excess coverage is subject to Social Security and Medicare taxes, collectively known as FICA taxes. Employers are required to withhold these taxes from an employee’s regular paychecks.

Federal income tax is not typically withheld from this imputed income. The responsibility for paying the income tax on this amount falls on the employee when they file their annual tax return. This can result in a higher tax liability or smaller refund if not accounted for, and some state income tax laws follow similar rules.

Rules for Specific Employee Situations

If an employee contributes to the cost of coverage with after-tax dollars, those payments can be used to offset the taxable amount. The total amount paid by the employee during the year is subtracted from the annual taxable value of the excess coverage, which can reduce or even eliminate the imputed income.

For retirees who continue to receive group-term life insurance coverage, the same tax rules generally apply. They must treat the value of coverage over $50,000 as taxable income.

The tax benefits can be lost if the plan is found to be discriminatory. If an insurance plan favors “key employees,” such as certain officers or owners, they are not eligible for the $50,000 exclusion. These employees must report the full cost of their coverage as taxable income. The taxable amount is the greater of the actual cost of the insurance or the cost determined by the IRS table.