Internal Revenue Code Section 79 Explained

Internal Revenue Code Section 79 allows employers to provide a tax-free benefit to their employees in the form of a qualified group term life insurance policy.

This benefit can be provided to employees at a lower cost than if they were to purchase the policy on their own.

The policy must be a group term life insurance policy and must be part of a qualified plan.

The employer's cost of providing the benefit is not subject to income tax.

If this caught your attention, see: Group Life Insurance Policy

Group life insurance is a type of life insurance that covers a group of people, usually employees of a company.

The Internal Revenue Code section 79 allows employers to provide group life insurance to their employees on a tax-free basis.

The maximum amount of group life insurance that can be provided tax-free is $50,000.

This limit applies to the total amount of coverage provided to each employee, not to the number of policies.

Employers can deduct the cost of group life insurance premiums from their taxable income.

Group life insurance premiums are typically paid by the employer, but can also be paid by the employee.

Check this out: Federal Employees' Group Life Insurance Act

The tax implications of Section 79 plans can be complex, but here's the bottom line: in a non-discriminatory plan, the first $50,000 of coverage is provided free to all employees. Any group coverage over this amount is deemed a benefit for which the employee must pay.

If the employer buys a permanent life insurance policy, the entire cost is no longer deductible, but a properly designed plan can make 20-40% of the premium deductible to the employee. The rest of the premium has to be bought with post-tax dollars.

You'll have to pay taxes on the benefit from other income, even though you never actually get the money to pay the taxes. This is known as "phantom income", and it's a bit like the issue with TIPS in a taxable account.

Expand your knowledge: Is Whole Life Insurance Tax Deductible

If an employer buys a permanent life insurance policy, the entire cost is no longer deductible, but if properly designed, 20-40% of the premium can be deductible to the employee.

Explore further: Is Life Insurance Deductible for Self Employed

The entire premium is deductible to the corporation, but as the employee, you only get to buy 20-40% of the premium with pre-tax dollars.

You have to pay taxes on that benefit from other income because this income to you is “phantom income” (you never saw it).

The employer gives you this policy (let's say $100K premium per year), then you have to pay taxes on $60-80K of it without ever actually getting the $100K with which to pay the taxes.

Curious to learn more? Check out: Does S Corp Pay Corporate Taxes

Calculating the tax liability is a crucial step in understanding the tax implications of a Section 79 plan. The first $50,000 of coverage is provided free to all employees, making it a non-discriminatory benefit.

Any group coverage over this amount is considered a benefit for which the employee must pay, and this excess amount is subject to tax. This is where the IRS published Table I rates come into play.

The pure insurance portion of the coverage is factored using these rates, which can be found on page 5 of the IRS publication. This helps determine the taxable amount of the benefit.

If a permanent insurance policy is used, the permanent benefit is calculated by taking into account premium(s) paid, accumulated and cash surrender value, and other policy factors.

Expand your knowledge: What Are the 4 Types of Permanent Life Insurance

To maintain the non-discriminatory form of a Section 79 plan, certain conditions must be met. The plan must cover at least 70% of employees.

One key requirement is that no more than 15% of the participants can be key employees. This ensures that the benefits are not skewed towards a select few.

Benefits must be based on reasonable classifications, such as age, salary, or job title. This helps to prevent discrimination and ensures that all employees are treated fairly.

Employees with less than six months of full-time employment may be excluded from the plan. This is a common practice, but it's essential to ensure that this exclusion is applied consistently.

Related reading: Key Man Life Insurance Tax Treatment

To prevent unequal benefits, the plan must use a uniform percentage of compensation or coverage brackets. For example, no bracket can be more than 2.5 times the next lowest bracket, and the lowest bracket must be at least 10% of the highest bracket.

Here's a summary of the key requirements:

To install a Section 79 plan, you'll need to meet certain requirements. The plan must provide a death benefit that's excludable from income under Code section 101(a). This means the plan needs to offer a death benefit that's not subject to income tax.

Here are the four main conditions that must be met:

These requirements are crucial to ensure that your Section 79 plan is compliant with the Internal Revenue Code.

Section 79 plans may require you to report certain transactions to the IRS, which can lead to substantial penalties and fines if not done correctly.

If you're required to report, it's crucial to do so accurately to avoid any issues with the IRS.

A section 79 plan may increase the likelihood of audit of the corporation, which can be a significant added stress.

These issues with the IRS are a major concern, making it a catch for many businesses.

Section 79 of the IRS Code allows employers to offer life insurance to their employees, with a tax deduction for the premium cost in Section 162 of the code.

Employers can deduct the premium cost for $50,000 of group life insurance for each employee, making it a relatively cheap benefit to offer.

The rules are straightforward, but the reality is often more complex, and employers might use this as an opportunity to offer a tiny amount of life insurance and write it off as a business expense.

A 30-year-old healthy male can buy $50,000 in 5-year level term insurance for around $100 per year, making it a cost-effective option for employers.

However, there's no rule that says the insurance offered has to be term life insurance, which is where things can get complicated.

Here's an interesting read: Life Insurance 10 Year Term