Payroll Tax Implications of Employer-Provided Employee Life Insurance

Employers may provide various types of employee life insurance beyond group-term life insurance, each with distinct payroll tax implications. Generally, any benefit of value paid by the employer for employees is included in the employees' gross income unless excluded by statute. The fair-market value, defined as the price an employee would pay a third party in an arm’s-length transaction, is used for valuation rather than the employer's cost or employee's perceived value.

For employer-provided group-term life insurance, IRS Publication 15-B permits excluding the cost of up to $50,000 of coverage from an employee’s taxable wages. Coverage exceeding this limit must be included in gross income based on IRS tables rather than actual premiums. The taxable amount is subject to income, Social Security, and Medicare taxes, though employers are not required to withhold income tax on this portion.

To qualify as group-term life insurance, policies must offer general death benefits without individual selection, cover a group of employees, and be carried by the employer. Policies for spouses, dependents, or those providing permanent benefits do not meet these criteria and are fully taxable, with withholding requirements applying. Spouse or dependent insurance may qualify for a de minimis exclusion if coverage is $2,000 or less.

Non-group-term life insurance benefits payable to an employee's beneficiary are valued at the employer's cost and included in gross income. Special IRS rules also exist for life insurance incidental to qualified retirement plans and for key employee insurance, such as split-dollar arrangements. These agreements specify ownership and cost-sharing details, allowing employers to provide benefits while managing employee expenses.

Split-dollar plans are not insurance policies but structured agreements allowing partial or full exclusion of insurance costs from employees' gross income. Insurance for key employees often serves business protection purposes, naming the business or owners as beneficiaries to offset financial risks associated with employee death.

Employers managing employee life insurance benefits must carefully navigate IRS valuation rules, taxation thresholds, and withholding obligations to ensure compliance while maximizing benefits. Understanding these nuanced payroll implications supports better benefit design and tax reporting accuracy in employee compensation strategies.