Student Question from: John C.
Course:  Income Tax – Gross Income Calculation

Student Question:

Hi.  I just wanted to verify that the employee premium in the example below is not prorated between the “tax-free” and taxable insurance coverage. And, if it’s not, why?   

Here is my calculation:  5 x 4.5% + 7 *0.5 % = 26% x 3000 = $780

Example: An employee age 44 is covered under a group term plan providing life insurance of $150,000 for all 12 months. The employee pays $50.00 for this coverage for the year. Table I is used to calculate the monthly cost of the $100,000 coverage that exceeds the $50,000 that is tax-free.

Table 1 Rates for Group Term Life Insurance
5-Year Age Bracket Cost per $1,000 of Insurance for One-Month Period
Under age 25 $.05
25 to 29 .06
30 to 34 .08
35 to 39 .09
40 to 44 .10
45 to 49 .15
50 to 54 .23
55 to 59 .43
60 to 64 .66
65 to 69 1.27
70 and above 2.06

Using Table I rates, 100 times $0.10 equals $10.00 of monthly costs. The annualized cost over 12 months is $120.00. After subtracting the employee’s payment of $50.00 for this coverage, the employee recognizes $70.00 in taxable income for the year.

Instructor Response:

Good question, John.  Let’s look at this a different way to see what is happening here.  The employee is getting $150,000 of coverage. The total cost of this coverage is $15 per month for 12 months = $180.

The employee is paying $50 of this cost; thus, the employer is paying the remaining $130 of this cost.  So, the ONLY tax question we need to consider is if the employer is providing a taxable benefit to the employee by paying that $130 and, if so, how much is that taxable benefit to the employee?  The issue we are considering has nothing to do with what the employee is paying; it is all about whether or not the employer is providing a taxable benefit.

To get our answer, the first $50,000 of coverage paid by the employer costs $5 x 12 = $60. Since the first $50,000 of coverage provided by an employer does not result in a taxable benefit for the employee, this $60 of premiums is tax-free to the employee. The remaining $70 of premiums being paid by the employer is for employer-paid coverage beyond $50,000 and is, therefore, a taxable benefit to the employee.