Internal Revenue Code § 79 provides an exclusion for the value of the first $50,000 of group term life insurance coverage whether carried directly or indirectly by an employer. If the total value of the group life insurance policy does not exceed $50,000, there are no tax consequences. If the cost of coverage is over $50,000, the imputed cost of the overage must be included in gross income and is subject to any applicable taxes. The IRS provides a premium table in Publication 15-B, under the “group-term life insurance coverage” heading, to calculate the imputed cost of coverage (not the actual premium). 

Consider the following example to assist in calculating imputed income: 

  • A 49-year-old employee is provided $200,000 in group term life insurance.
  • The value is $150,000 over the excludable value subject to imputed income.
  • The annualized calculation would be 150 multiplied by the table rate (reflected as cost per $1,000) for age bracket 45–49 multiplied by 12.

Due to this nontaxable exclusion, nondiscrimination testing is required to maintain the tax advantage. Nondiscrimination tests, established in § 79, are used to ensure the group term life insurance benefit is not favoring highly compensated employees (HCEs) above all other employees as follows:

  1. The eligibility test requires a plan to satisfy at least one of the four criteria below:
    1. The plan is provided through a § 125 cafeteria plan and passed the § 125 eligibility test;
    2. The plan benefits a minimum of 70% of employees except for allowable exclusions;
    3. At least 85% of non-excludable employees eligible to participate are not key employees; or
    4. The plan benefits a nondiscriminatory class of employees.
  2. The benefits test requires a plan to satisfy both of the following criteria:
    1. The benefits provided to key employees are also provided to all other employees; and
    2. The benefits are uniform in relation to an employee’s compensation.

Failing either of the required nondiscrimination tests may result in key employees losing the exclusion provided for the first $50,000 of their group term life benefit and may be required to include the greater of the table rate or the actual cost of their coverage as income. A failed test does not affect non-key employees.

Definitions

Carried directly or indirectly is defined by the IRS as follows: “The employer pays any cost of the life insurance, 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 (the “straddle” rule).”

Key employee is defined by the IRS in Publication 15-B as an officer of the organization with an annual pay at or above the IRS threshold of $215,000 for 2023 and $220,000 for 2024, or an employee with 5% ownership of the business, or a 1% ownership with an annual pay over $150,000 for 2023 and $155,000 for 2024.

Allowable exclusions refer to employees who are excluded in the testing. Excluded employees are those who have not completed three years of service, are part time or seasonal, are nonresident aliens who receive no U.S. source income, or are covered by a collective bargaining agreement.