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.