Given the increased taxation climate to many businesses, the new administration is looking for every penny owed the federal government. Please bear with me as we explain the simple, but often over looked detail of Section 79 (Imputed Income) with Voluntary Life Rates.
According to MetLife Insurance Company, Section 1.79-1(a) of the regulations provides that life insurance is group-term life insurance subject to Section 79 of the Code if it meets the following conditions:
(1) It provides a general death benefit that is excludable from gross income under section 101(a).
(2) It is provided to a group of employees.
(3) It is provided under a policy carried directly or indirectly by the employer.
(4) The amount of insurance provided to each employee is computed under a formula that precludes individual selection. In general, this condition may be satisfied even if the amount of insurance provided is determined under a limited number of alternative schedules that are based on the amount each employee elects to contribute.
In the above section it is necessary to focus on (3)' It is provided under a policy that is carried directly or indirectly by the employer.' What exactly does that mean?
Section 1.79-0 of the regulations provides that a policy of life insurance is carried directly or indirectly by the employer if —
(a) The employer pays any part of the cost of the life insurance directly or through another person; or
(b) The employer or two or more employers arrange for payment of the cost of the life insurance by their employees and charge at least one employee less than the cost of his or her insurance, as determined under Table I of section 1.79-3(d)(2), and at least one other employee more than the cost of his or her insurance, determined in the same way.
The legislative history of section 79 of the Code states that the cost of group-term life insurance protection above the exclusion level ($50,000 if paid by employer) is to be taxed to an employee “if it is provided under a plan arranged for by the employer whether the protection the employee receives (over and above that provided by his own contributions) is provided directly by the employer, or indirectly by the employer's charging more than the cost of the insurance to other employees (such as those in younger age brackets) and less to those in the older age brackets, such as the specific employee in question.” S. Rep. No. 830, 88 th Cong., 2d Sess. 1 (1964), 1964-1 (Part 2) C.B. 502, 550.
As the above regulations and the legislative intent clearly demonstrate that a group life plan that is paid for by the employer is subject to Section 79 and its imputed income requirements. That is quite clear and usually not in dispute. However, that language also clearly shows that a plan that is paid entirely by the employee with after tax dollars but 'straddles' Table 1 is considered to be 'indirectly' carried by the employer and it subjects its participants to imputed income.
If a group has a rate for the age 30-34 bracket that is .09/1000 and a rate at the 50-54 bracket that is .22/1000 you have a situation where you have one rate that is above Table 1 and one below Table 1. Thus the rates straddle. The IRS considers this to be a situation wherein the younger age bracket is paying more than they should while the older ages bracket is paying less than they should. The rates are not sloped properly and one group (the younger ones) are paying more and subsidizing the older age bracket. Given that there is a subsidy (according to the IRS) these plans are improperly structured and subject the entire plan to imputed income calculations even though they are paid fully by the employee with after tax dollars.
The above rules are quite clear in an Optional Life plan that uses unismoke rates but what about plans with smoker/non smoker rates. The IRS has provided an opinion in a private letter ruling (PRL 9149033). In this PLR the IRS took the position that a company could treat a smoker/non smoker plan as two plans for straddle testing purposes. If the smoker plan had all their rates above Table 1 and the non smoker rates were below Table 1 the IRS did not consider this plan to 'straddle' Table 1. As long as both plans could justify that their rates actuarially were separate the plans were considered not to straddle and thus be subject to Section 79 and its imputed income requirements.
Nelson, Mitch “Heads up on Imputed Income Tests for Voluntary Life Plans,” Met Life Email 2009