Revenue Code 120 for Group Legal Service Plans

A group legal services plan was a specific employee benefit governed by Section 120 of the Internal Revenue Code. This provision allowed employers to offer legal services to their employees as a tax-free benefit.

Section 120 has expired and is no longer a part of the U.S. tax code. Congress allowed the provision to terminate, with its final effective date being June 30, 1992. Since that time, multiple proposals to reinstate or make the benefit permanent have not been enacted into law.

The Employee Tax Exclusion

Under the rule, an employee’s gross income did not include amounts contributed by an employer to a qualified group legal services plan. This meant the value of legal services provided was a tax-free fringe benefit, much like health insurance contributions are often treated. The exclusion was capped, preventing unlimited tax-free benefits; for instance, the value of coverage could not exceed an annual limit of $70 per employee.

For example, if an employee in a 22% federal tax bracket received legal services valued at $500 through a non-qualified plan, they would owe $110 in federal income taxes on that benefit. Under the expired Section 120, that $110 in tax liability would not have existed. For the employer, the contributions to the plan were deductible as an ordinary and necessary business expense, similar to other employee compensation and benefit costs. The employer would pay for the plan, and the employee would receive the benefit without an increase in their taxable wages reported on their Form W-2.

Qualified Plan Requirements

A group legal services plan had to meet several requirements. A plan had to be a separate, written document that clearly defined the benefits, eligibility rules, and operational procedures. The plan also had to be established for the exclusive benefit of the company’s employees, their spouses, and their dependents.

A central pillar of qualification was nondiscrimination. The plan’s contributions and benefits could not discriminate in favor of highly compensated employees, officers, shareholders, or other business owners. To enforce this, no more than 25% of the total amount contributed to the plan during the year could be for the benefit of individuals who were shareholders or owners holding more than a 5% stake in the company. These rules ensured a broad base of employees had access to the plan.

Permissible Legal Services

The scope of legal assistance available under a qualified plan was clearly defined and limited to what the law termed “personal legal services.” Examples of covered services typically included matters such as drafting a will or creating a trust for estate planning purposes. Assistance with real estate transactions, like the purchase or sale of a personal residence, was also a permissible benefit, as were family law matters related to adoption, separation, or divorce.

Conversely, the law prohibited the plan from covering legal services related to an employee’s trade or business. An employee could not use the plan to get tax-free legal advice for their side business or professional practice. Legal matters involving income-producing property, such as disputes with a tenant in a rental property owned by the employee, were also outside the scope of permissible services.

Current Status and Employer Options

Any legal service benefit provided by an employer to an employee today is considered a taxable fringe benefit. This means the fair market value of the service must be included in the employee’s income and is subject to federal income, Social Security, and Medicare taxes.

Employers wishing to offer legal benefits now have different options. A common approach is to offer a voluntary legal plan on a post-tax basis where the employer arranges for access to a network of attorneys at a discounted group rate, and employees who enroll pay the premiums with post-tax money. Another option is for the employer to pay for the legal plan but to include its value in the employee’s taxable wages. Some employers also offer limited legal resources through a broader Employee Assistance Program (EAP), which may have its own distinct tax treatment.