A: Yes. The cost of providing up to $50,000 in coverage is deductible as an expense to the employer and, best of all, it doesn't create a tax event for the employee either. It's a win/win. For amounts over $50,000, however, employers must include the cost of excess insurance as taxable income to the employee.

Q: Does the same exclusion apply to dependent life coverage?

A:  No…and yes. For dependent life coverage, it is not taxable if paid by the employer and the face amount is $2,000 or less. But, for amounts over $2,000, the entire cost for the insurance (including the first $2,000) is taxable to the employee.

Q: Are there any special rules to ensure equity within the employee population?

A:  Yes, there are a couple of guidelines to be aware of.

• The first is known as imputed income rules. Typically, these rules don't apply to employee paid coverage as long as: 1) the premiums are paid with after-tax contributions; and, 2) the rates among employees don't fall too far outside a defined table of parameters provided by the IRS (i.e. they don't straddle).  If both tests are not met, however, negative tax implications occur, especially for key employees. 
• If a group life insurance plan discriminates in favor of key employees, even the cost of the first $50,000 may need to be included in taxable income.  It can also result in a 100% employee-paid life policy being brought under an employer-provided plan, resulting in additional tax implications.

Q: Are life insurance proceeds paid to beneficiaries taxable? 

A:  No. Even in the case of accelerated benefits (which are paid to a member in advance of death), they are also non-taxable when based on a terminal illness.  But, be careful.  Receipt of accelerated benefits could affect the member's eligibility for public assistance.   

Q: Are disability payments taxable to the employee? 

A: It depends. Generally, disability benefits are taxable when the premiums are paid with pre-tax dollars but it can also be the other way around, meaning they are non-taxable when premiums are paid with post-tax dollars. Here are a few more tips when it comes to disability insurance:    

• For employer paid disability plans, premiums which are deducted as a business expense would cause claim benefits to be taxable to the employee.
• In the case of voluntary disability plans, premiums are usually paid by the employee with after-tax dollars (via payroll deduction) and, as such, benefits would be considered tax-free. 
• The employer can "gross up" the payment by adding post-tax dollars to the employee's salary to cover the cost of the premium and associated taxes (which is reported as taxable income to the employee) also resulting in a tax free benefit.  One consideration with the "gross up" structure is that an employer could purchase a policy with a lower benefit percentage at a lower price and potentially provide employees with a higher level of income replacement when compared to take home pay due to the tax free benefit.
• With a core/buy-up disability plan, the employer pays the premium for a base level of coverage and the employee can exercise an option to purchase additional coverage (for additional premium).  The claim benefits from the core plan, if paid, are fully taxed to the employee since premiums were paid 100% on a pre-tax basis by the employer.  The claim benefit from the buy-up portion is tax free because the employee paid the premium with post-tax dollars.

Q: What other options exist to help mitigate tax liability?

A: One important option is the use of a Section 125 plan, which allows employees to pay certain qualified insurance premiums with pre-tax dollars. This can result in savings for employees that range from 20% – 40% or more, depending on the employee's tax bracket.  These are commonly used by employers, especially for health insurance. 

Q:  Can life insurance premiums be run through a Section 125? 

A:  Yes. But, most employers don't choose to do that because there is a large amount of bookkeeping involved for a relatively small amount of premium saved.  The reason is that most employees purchase insurance above the $50,000 threshold and, therefore, the employer must consider part of the premium as pre-tax and part post-tax, which is complicated and time consuming to manage.

Obviously, there are various rules and strategies to consider, which is why you should always recommend your clients to seek tax advice from a qualified tax advisor.  Still, some basic application of tax topics can assist your clients through the quagmire of tax consideration and, at the same time, differentiate yourself from your peers.