Offering term life insurance to a group of employees does not constitute a group term life insurance plan. This designation generally rests on providing term life insurance to at least 10 full-time employees who are members of a group of employees. This minimum coverage rule has two major exceptions. Exhibit 7.1 lists them.
Employers may offer group term life insurance on a contributory or noncontributory basis. Under contributory plans, employees pay the entire insurance premium or they share the cost with their employer. Under noncontributory plans, the employer pays the entire premium for coverage within designated limits (e.g., twice an employee’s annual salary). Most group term life insurance is offered on a noncontributory basis mainly because the employer receives substantially higher tax benefits with noncontributory than with contributory plans.
Term life insurance plans must meet four criteria for classification as a group term plan. Meeting all four criteria makes a group term plan eligible for favorable tax treatment under Internal Revenue Code Section 79. Exhibit 7.2 lists these four criteria.
Section 79 of the Internal Revenue Code specifies that the cost of employer- provided group term life insurance qualifies as a tax-free benefit to an employee, with some exceptions. Section 79 includes the following five criteria, which are described in Exhibit 7.3, to determine tax qualification:
• General rule for tax benefits of group term life insurance.
• Exceptions to the general rule that imposes taxation.
• Determination of cost of insurance.
• Nondiscrimination requirements—nondiscrimination rules prohibit employers from discriminating in favor of highly compensated employees in contributions or benefits, availability of benefits, rights, or plan features.
• Employee includes former employee for Internal Revenue Service Code, Section 79.
EXHIBIT 7.1 Exceptions for Minimum Group Term Life Insurance Coverage
A group may include fewer than 10 full-time employees if:
First, the insurance is provided to all full-time employees, including full-time
employees who show evidence of insurability when required. Employees
must receive insurance coverage as a percentage of compensation or on
coverage brackets set by the insurance company. Insurance companies may
reduce benefits for full-time employees with some limitations to evidence
Second, the insurance is provided under a common plan to the employees of two or more unrelated employers. In addition, the insurance is restricted to, but mandatory for, all employees who belong to, or are represented by, a union or other employee representative. Finally, evidence of insurability does not affect an employee’s eligibility for insurance or the amount of insurance provided to that employee.
EXHIBIT 7.2 Criteria for Exempting Group Term Life Insurance for Taxation
- It provides a general death benefit that is excludable from gross income under Internal Revenue Code, Section 101(a).
- It is provided to a group of employees.
- It is provided under a policy carried directly or indirectly by the employer.
- The amount of insurance provided to each employee is computed under a formula that precludes individual selection. This formula must be based on factors such as age, years of service, compensation, or position. 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. However, the amount of insurance provided under each schedule must be computed under a formula that precludes individual selection.
EXHIBIT 7.3 Internal Revenue Code Section 79: Group Term Life Insurance Purchased for Employees
79(a) General Rule
There shall be included in the gross income of an employee for the taxable year an amount equal to the cost of group term life insurance on his life provided for part or all of such year under a policy (or policies) carried directly or indirectly by his employer (or employers); but only to the extent that such cost exceeds the sum of—
79(a)(1) the cost of $50,000 of such insurance, and
79(a)(2) the amount (if any) paid by the employee toward the purchase of such insurance.
Subsection (a) shall not apply to—
79(b)(1) the cost of group term life insurance on the life of an individual which is provided under a policy
carried directly or indirectly by an employer after such individual has terminated his employment with
such employer and is disabled (within the meaning of section 72(m)(7)),
79(b)(2) the cost of any portion of the group term life insurance on the life of an employee provided
during part or all of the taxable year of the employee under which—
79(b)(2)(A) the employer is directly or indirectly the beneficiary, or 79(b)(2)(B) a person described in
section 170(c) is the sole beneficiary, for the entire period during such taxable year for which the
employee receives such insurance, and 79(b)(3) the cost of any group term life insurance which is
provided under a contract to which section 72(m)(3) applies.
79(c) Determination of Cost of Insurance
For purposes of this section and section 6052, the cost of group term insurance on the life of an employee provided during any period shall be determined on the basis of uniform premiums (computed on the basis of five-year age brackets) prescribed by regulations by the Secretary.
79(d) Nondiscrimination Requirements
79(d)(1) In general, in the case of a discriminatory group term life insurance plan—
79(d)(1)(A) subsection (a)(1) shall not apply with respect to any key employee, and 79(d)(1)(B) the cost
of group term life insurance on the life of any key employee shall be the greater of—
79(d)(1)(B)(i) such cost determined without regard to subsection (c), or 79(d)(1)(B)(ii) such cost
determined with regard to subsection (c).
79(d)(2) Discriminatory Group Term Life Insurance Plan
For purposes of this subsection, the term “discriminatory group term life insurance plan” means any plan
of an employer for providing group term life insurance unless—
79(d)(2)(A) the plan does not discriminate in favor of key employees as to eligibility to participate, and
79(d)(2)(B) the type and amount of benefits available under the plan do not discriminate in favor of
participants who are key employees.
79(d)(3) Nondiscriminatory Eligibility Classification
79(d)(3)(A) In general, a plan does not meet the requirements of subparagraph (A) of paragraph (2)
79(d)(3)(A)(i) such plan benefits 70 percent or more of all employees of the employer, 79(d)(3)(A)(ii) at
least 85 percent of all employees who are participants under the plan are not key employees,
79(d)(3)(A)(iii) such plan benefits such employees as qualify under a classification set up by the
employer and found by the Secretary not to be discriminatory in favor of key employees, or
79(d)(3)(A)(iv) in the case of a plan which is a part of a cafeteria plan, the requirements of section
125 are met.
79(d)(3)(B) Exclusion of Certain Employees
For purposes of subparagraph (A), there may be excluded from consideration—
79(d)(3)(B)(i) employees who have not completed 3 years of service; 79(d)(3)(B)(ii) part-time or
seasonal employees; 79(d)(3)(B)(iii) employees not included in the plan who are included in a unit of
employees covered by an agreement between employee representatives and one or more employers
which the Secretary finds to be a collective bargaining agreement, if the benefits provided under the
plan were the subject of good faith bargaining between such employee representatives and such
employer or employers; and 79(d)(3)(B)(iv) employees who are nonresident aliens and who receive no
earned income (within the meaning of section 911(d)(2)) from the employer which constitutes
income from sources within the United States (within the meaning of section 861(a)(3)).
79(d)(4) Nondiscriminatory Benefits
A plan does not meet the requirements of paragraph (2)(B) unless all benefits available to participants
who are key employees are available to all other participants.
79(d)(5) Special Rule
A plan shall not fail to meet the requirements of paragraph (2)(B) merely because the amount of life
insurance on behalf of the employees under the plan bears a uniform relationship to the total
compensation or the basic or regular rate of compensation of such employees.
79(d)(6) Key Employee Defined
For purposes of this subsection, the term “key employee” has the meaning given to such term by
paragraph (1) of section 416(i). Such term also includes any former employee if such employee when he
retired or separated from service was a key employee.
79(d)(7) Exemption for Church Plans
79(d)(7)(A) In general, this subsection shall not apply to a church plan maintained for church
employees. 79(d)(7)(B) Definitions: For purposes of subparagraph (A), the term “church plan” and
“church employee” have the meaning given such terms by paragraphs (1) and (3)(B) of section 414(e),
respectively, except that—79(d)(7)(B)(i) section 414(e) shall be applied by substituting “section
501(c)(3)” for “section 501” each place it appears, and 79(d)(7)(B)(ii) the term “church employee” shall
not include an employee of—79(d)(7)(B)(ii)(I) an organization described in section 170(b)(1)(A)(ii) above
the secondary school level (other than a school for religious training), 79(d)(7)(B)(ii)(II) an organization
described in section 170(b)(1)(A)(iii), and 79(d)(7)(B)(ii)(III) an organization described in section 501(c)(3),
the basis of the exemption for which is substantially similar to the basis for exemption of an
organization described in subclause (II).
79(d)(8) Treatment of Former Employees
To the extent provided in regulations, this subsection shall be applied separately with respect to former
79(e) Employee Includes Former Employee
For purposes of this section, the term “employee” includes a former employee.