Does your employer provide you with group term life insurance? Is the coverage higher than $50,000? If you answered yes to both of these questions then this employee benefit may create undesirable income tax consequences for you.
“Phantom income”
The first $50,000 of group term life coverage provided by your employer is tax free to you and will not have an effect on your tax bill. With that said, employer-paid costs of group term coverage in excess of $50,000 is taxable income to you. It’s included in the taxable wages reported on your Form W-2. This produces “phantom income”, which means you are being taxed on income that you have never received.
What’s worse, the cost of group term insurance is determined by a table prepared by the IRS even if the employer’s actual cost is less than the cost figured under the table. Under these determinations, the amount of taxable phantom income attributed to an older employee is often higher than the premium the employee would pay for comparable coverage under an individual term policy. This tax trap gets worse as the employee gets older and as the amount of his or her compensation increases.
Determining your “Phantom income” – Check your W-2
What should you do if you think the tax cost of employer-provided group term life insurance is undesirably high? First, you should establish if this is actually the case. If a specific dollar amount appears in Box 12 of your Form W-2 (with code “C”), that dollar amount represents your employer’s cost of providing you with group-term life insurance coverage in excess of $50,000, less any amount you paid for the coverage. You’re responsible for federal, state and local taxes on the amount that appears in Box 12 and for the associated Social Security and Medicare taxes as well.
But keep in mind that the amount in Box 12 is already included as part of your total “Wages, tips and other compensation” in Box 1 of the W-2, and it’s the Box 1 amount that’s reported on your tax return.
Consider some options
If you decide that the tax cost is too high for the benefit you’re getting in return, you should find out whether your employer has a “carve-out” plan (a plan that carves out selected employees from group term coverage) or, if not, whether it would be willing to create one. There are several different types of carve-out plans that employers can offer to their employees.
For example, the employer can continue to provide $50,000 of group term insurance (since there’s no tax cost for the first $50,000 of coverage). Then, the employer can either provide the employee with an individual policy for the balance of the coverage, or give the employee the amount the employer would have spent for the excess coverage as a cash bonus that the employee can use to pay the premiums on an individual policy.
Call your Wegner CPAs tax professional if you have questions about group term coverage or how much it is adding to your tax bill.
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