PLR 200033011: separate life insurance policies and taxable family coverage

Plain-English summary

A company offered employees basic life insurance paid by the company and optional coverage paid by employees. The IRS ruled that the company could treat the basic coverage and the optional coverage for smokers and nonsmokers as separate policies under section 79 because their premiums were properly allocated. The optional employee coverage would therefore create no imputed income under that section. Employees buying spouse coverage, however, must include any excess of its Table I cost over what they paid. For children's coverage, the IRS declined a broad ruling on whether a shortfall qualifies as a de minimis fringe benefit; the company must compare each employee's payment with the Table I cost and assess any excess individually.

Ruling snapshot

• Question: Can the company separate its life insurance policies for section 79, and do spouse and child coverage create employee income?
• Outcome: Mixed. Separate treatment was allowed for employee coverage; spouse coverage can create income, and child coverage requires individual analysis.
• Key authorities: IRC §§ 61(a), 79, and 132(e); Treas. Reg. §§ 1.61-2(d)(2)(ii)(b), 1.79-0, and 1.79-3(d)(2); Notice 89-110.

Full text (IRS public release)

Internal Revenue Service                        Department of the Treasury

Index Number: 61.53-00 and 79-00.00             Washington, DC 20224



Number: 200033011                               Person to Contact:
Release Date: 8/18/2000                         Telephone Number:

                                                Refer Reply To:
                                                CC:TEGE-PLR-118030-99
                                                Date:
                                                May 12, 2000

In Re:



Legend

Company =

Insurer X =


Dear Mr.

         This letter is in response to a request submitted on the behalf of Company by
its authorized representatives for rulings concerning Company’s group term life
insurance program.

        Company provides basic group term life insurance on the lives of eligible non-
union employees in the amount of 100% of annual compensation, at no cost to the
employee. In addition, an eligible employee may purchase supplemental coverage on
his or her life, as well as insurance on the lives of the employee’s children and spouse.

        The supplemental coverage on the lives of the employees is paid for entirely by
the employees on an after-tax basis. In the past, the premiums charged to the
employees for the coverage made no distinction between smoking employees and non-
smoking employees. In an effort to improve the fairness and actuarial soundness of the
supplemental coverage for its employees, Company has established a new
supplemental plan. Under the new plan, the premium rates charged to the employees
are segregated between smokers and non-smokers. For all age groups, the premium
charged to smokers are the same as or more than the premium rates of Table I
(effective, generally, July 1, 1999) of section 1.79-3(d)(2) of the Income Tax
Regulations. For all age groups, the premium charged to non-smokers are the same as
or less than the Table I premium rates. Employees may purchase coverage of one-to-
five times earnings, not to exceed a specified amount. Some employees, may continue
to purchase a reduced amount of coverage after retirement. For the remaining
terminated employees, the full amount of the supplemental coverage may be continued
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for 18 months after termination.

       The coverages for both the basic and the supplemental insurance are purchased
from Insurer X. The information submitted evidences that the rate structure for the
supplemental life coverage is self-supporting and is not subsidized by the basic life
coverage. The premium rates for the supplemental coverage were determined
separately and independently of the premium rates for the basic coverage, and the
finances of the supplemental and basic coverages will be accounted for separately and
independently. For example, the experience rating for each of the plans is separately
developed based on historical mortality, interest income, administrative expenses and
similar factors; reserves are not shifted between policies; no premium loading expenses
allocable to one plan are included in the premiums of the other plan; and, the dividend
and rate credits attributable to each of the plans are determined separately from each
other, based on independent retrospective adjustments. The information submitted
also evidences that the premiums charged to smokers and those charged to non-
smokers were developed separately from each other and are self-supporting. For
example, separate estimated claim rates were calculated for each class. In the future,
the premium rates for each class will be evaluated and adjusted separately. No
premium loadings, reserves or experience credits will be shifted from one class to
another.

       Company now wishes to elect to treat as separate policies, for purposes of
section 79 of the Internal Revenue Code, the coverage under the basic policy, the
coverage provided to smokers under the supplemental policy, and the coverage
provided to nonsmokers under the supplemental policy.

       In addition to group-term life insurance coverage on their own lives, employees
of Company may also purchase life insurance coverage on the lives of their spouses
and children. The coverage, purchased from Insurer X, is paid for entirely by the
employee on an after-tax basis. Coverage may be purchased on children in the face
amounts of $10,000 per child for a flat premium amount per month. Coverage may be
purchased on a spouse in the face amount of $25,000, $50,000, $100,000 or $150,000
at the same rates (using the spouse’s age) as coverage purchased on the lives of
employees. Although the policies are available to Company’s employees because of
their employment relationship, the taxpayer represents that the particular rates
established by Insurer X for Company’s employees are not a product of the
employment relationship between Company and its employees. Rather, Company
represents that the rates for the spousal insurance coverage perfectly reflect the market
value of obtaining supplemental insurance coverage under a group contract, with all of
its benefits and limitations. Company requests rulings that the life insurance coverage
on the spouses and children does not result in income to the employees.

                                   LAW AND ANALYSIS
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Insurance Coverage on the Lives of the Employees

       The taxation of employer-provided group term insurance on the life of an
employee is governed by section 79 of the Code. Assuming a group term plan meets
the non-discrimination requirements of section 79(d), $50,000 of such coverage is
excludable from the each employee’s income. For coverage above $50,000, section 79
requires an employee to include in income an amount equal to the cost of life insurance
provided under a policy carried directly or indirectly by his or her employer (less any
amounts paid by the employee toward the purchase of such insurance). Section 79(c)
requires the "cost" of the insurance to be computed by using the uniform premiums
prescribed in Table I of the section 79 regulations.

        Section 1.79-1(a) of the regulations sets forth the conditions that must be met
before a policy of life insurance will be considered group term life insurance for
purposes of section 79 of the Code. The condition relevant to this ruling request is that
the life insurance be "provided under a policy carried directly or indirectly by the
employer." Treas. Reg. § 1.79-1(a)(3) of the regulations.

       The meaning of the term "policy," for purposes of section 79 of the Code, is
found in Treas. Reg. §1.79-0. Under that definition, the term "policy" includes two or
more obligations of an insurer (or its affiliates) that are sold in conjunction. Obligations
that are offered or available to members of a group of employees are sold in
conjunction if they are offered or available because of the employment relationship.
These obligations of the same insurer are aggregated despite actuarial sufficiency of
the premiums charged for each obligation, and even if the obligations are contained in
separate documents. The regulations, however, allow an employer to elect to treat two
or more obligations, each of which provides no permanent benefits, as separate
policies if the premiums are properly allocated among such policies.

       Thus, an employer may have more than one policy. However, each policy must
be tested separately to determine if it is carried directly or indirectly by the employer. If
a policy is not carried directly or indirectly by the employer, no income will be imputed to
an employee under section 79 of the Code on account of the insurance provided under
that policy.

        The definition of the phrase "carried directly or indirectly by the employer" is also
found in Treas. Reg. §1.79-0. Under that definition, 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
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       one employee less than the cost of his or her insurance, as determined
       under Table I..., and at least one more than the cost of his or her
       insurance, determined in the same way.

       Applying the above rules to the Company’s group term life insurance plan
covering the lives of the employees, the basic and the supplemental insurance are
available to the Company’s employees because of the employment relationship. In
addition, both the basic and the supplemental insurance are purchased from the same
insurer. Therefore, all obligations contained in the basic and the supplemental plan will
be treated as a single "policy" for purposes of section 79, unless the Company meets
the conditions to elect to treat such obligations as separate policies. Because neither
the basic nor the supplemental coverage contains permanent benefits, the only
requirement for electing separate treatment is that the premiums be properly allocated.

       Based on the representations made, we conclude that the insurance premiums
are properly allocated between the coverage provided under the basic policy and that
provided under the supplemental policy, so that the Company may elect to treat the
basic coverage as a separate policy for purposes of section 79 of the Code. Because
the Company pays the cost of the basic insurance coverage, the life insurance provided
under the basic plan is within the definition of "carried directly or indirectly by the
employer."

        Based on the representations made, we also conclude that the premiums
charged for the supplemental coverage: (1) are not financed by the employer, and (2)
are properly allocated between the insurance for the smokers and the insurance for the
nonsmokers. Furthermore, we conclude that coverage provided to the smokers is a
"obligation of an insurer" (as that term is used in the definition of "policy"), as is the
coverage provided to the nonsmokers. Because the premiums charged for these
obligations are "properly allocated," the Company may elect to treat each of these
obligations as a separate policy for determining whether the insurance is within the
definition of "carried directly or indirectly by the employer."

       Applying that definition to the submitted schedules of premiums to be charged to
smokers and nonsmokers, we conclude that neither the smokers’ coverage nor the
nonsmokers’ coverage is "carried directly or indirectly by the employer" for purposes of
section 79 of the Code. Accordingly, only the group term life insurance provided
through the Company’s basic policy will be subject to the inclusion rules of section 79.

Insurance Coverage on the Lives of Spouses and Children

        Section 61(a)(1) of the Code generally provides that gross income means all
income from whatever source derived, including compensation for services, fees,
commissions, fringe benefits and similar items. Treas. Reg. § 1.61-21(a)(3) provides
that a fringe benefit provided in connection with the performance of services shall be
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considered to have been provided as compensation for such services. In general, an
employee must include in gross income the amount by which the fair market value of
the fringe benefit exceeds the sum of (i) the amount, if any, paid for the benefit by or on
behalf of the recipient, and (ii) the amount, if any, specifically excluded from gross
income by some other section of subtitle A of the Code. Treas. Reg. § 1.61-21(b)(1).
The fair market value of a fringe benefit is the amount that an individual would have to
pay for the particular fringe benefit in an arm’s length transaction. Treas. Reg. § 1.61-
21(b)(2).

        Special rules apply when the fringe benefit provided to the employee is group
term life insurance. For group term life insurance on the life of an individual other than
an employee (such as the spouse or dependent of the employee) provided in
connection with the performance of services by the employee, section 1.61-1(d)(2)(ii)(b)
of the regulations states that the “cost” of the insurance is includible in the gross income
of the employee. The “cost” of dependent group term life insurance must be
determined under Table I of section 1.79-3(d)(2) of the regulations. The uniform
premium rates in Table I are based on average costs for employer-provided group life
insurance. However, the cost of employer-provided dependent group term life
insurance is not includible in gross income to the extent such cost is paid by the
employee on an after-tax basis. Thus, the amount includible in income is the cost (as
determined under Table I) less the amount paid for the insurance by the employee.
Nothing is includible, however, if such amount is “de minimis”. See Notice 89-110,
1989-2 C.B. 447.

        The taxpayer asserts that the specific rule provided in Treas. Reg. § 1.61-
2(d)(2)(ii)(b) that governs the tax treatment of dependent group term life insurance does
not apply to the spousal insurance coverage provided under Company’s plan. The
taxpayer asserts that, because the spousal insurance coverage does not satisfy the
requirement in section 79 that the policy be “carried directly or indirectly by the
employer”, it does not constitute “group term life insurance” within the meaning of
Treas. Reg. § 1.79-0. Because the specific rule in Treas. Reg. § 1.61-1(d)(2)(ii)(b)
expressly applies to “group term life insurance”, and the spousal coverage is not group-
term life insurance, the taxpayer contends that the more general rule at Treas. Reg. §
1.61-21(b)(1) applies, requiring that an employee include in gross income the amount
by which the fair market value of the fringe benefit exceeds the sum of (i) the amount, if
any, paid for the benefit by or on behalf of the recipient, and (ii) the amount, if any,
specifically excluded from gross income by some other section of subtitle A of the
Code. Insofar as the employees pay fair market value for the spousal insurance
coverage, the taxpayer asserts that such coverage results in no income to the
employees.

       We disagree with the taxpayer’s assertion that the spousal coverage does not
constitute “group term life insurance” because it fails to satisfy the requirement in
section 79 that the insurance be “carried directly or indirectly by the employer.” We
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conclude that the phrase “group term life insurance,” as used in Treas. Reg.
§ 1.61-2(d)(2)(ii)(b), should be interpreted in accordance with its plain meaning, i.e.,
term insurance provided to a group. The spousal coverage is clearly term insurance,
and the taxpayer concedes that it is provided to Company’s employees (a “group”) by
virtue of their employment relationship. We base our conclusion on the legislative
history of I.R.C. § 79, and on the fact that the section 79 regulations expressly state that
the provisions in section 79 apply only for purposes of section 79.

        Prior to enactment of section 79, Treasury regulations provided that an employee
was not required to include in income the cost of group term life insurance provided by
an employer on the employee’s life. The Treasury’s administrative position was
apparently grounded on a combination of policy factors such as encouragement of the
socially desirable group protection of a deceased employee’s family, and the fact that
such protection was not usually very extensive or expensive. See Enright v.
Commissioner, 56 T.C. 1261 (1971). In enacting section 79, Congress in effect
revoked the prior administrative exclusion of this type of compensation beyond the cost
of $50,000 protection, while at the same time providing a precise statutory exclusion for
such cost, up to that amount. The enactment of section 79 was not intended to affect
the taxation of other types of insurance provided to employees by their employers.
H. Rept. No. 744, 88th Cong., 1st Sess. (1963), 1964-1 C.B. (Part 2) 277, 278. Unless
excluded by section 79, all other variations from employee group-term life insurance are
to be treated for what they are – compensation within the meaning of section 61.
Enright, supra, at p. 1268.

       Thus, the purpose of section 79 was not to define group term life insurance.
Instead, section 79 was enacted to carve out a limited exclusion for a specific type and
amount of group term life insurance that is not subject to taxation, while at the same
time clarifying that all other group term life insurance not meeting the requirements of
section 79 is to be included in compensation.

       Moreover, the application of the provisions in section 79 and its implementing
regulations is expressly limited for purposes of section 79 and the section 79
regulations only. For example, Treas. Reg. §1.79-0 states that the definitions in that
section, including the definition of “carried directly or indirectly by the employer,” apply
for purposes of “section 79, this section, and sections 1.79-1, 1.79-2, and 1.79-3.”
Similarly, section 1.79-1(a), which states the general requirements for group term life
insurance, provides that “[l]ife insurance is not group-term life insurance for purposes
of section 79 unless it meets the following conditions...” (emphasis added). Finally,
section 1.79-3(g)(2) expressly provides: “An amount equal to the cost of group-term life
insurance on the life of the spouse or other family member of the employee which is
provided under a policy of group-term life insurance carried directly or indirectly by his
employer is not subject to the provisions of section 79 since it is not on the life of the
employee. See paragraph (d)(2)(ii)(b) of § 1.61-2 for rules regarding the tax treatment
of such insurance.” See also, Treas. Reg. § 1.79-1(f)(2) (providing that section 61(a)
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and the regulations thereunder provide rules relating to life insurance not meeting the
requirements of section 79 because it is on the life of a non-employee, such as an
employee’s spouse).

       Accordingly, we conclude that Treas. Reg. § 1.61-2(d)(2)(ii)(b) applies to
Company’s spousal insurance coverage such that an employee purchasing such
insurance must include in income an amount equal to the difference between the “cost”
of the spousal coverage (as determined under Treas. Reg. § 1.79-3(d)(2)), and the
amount paid by the employee for the insurance.

        The taxpayer also requests a ruling that the group term life insurance provided to
employees on the lives of their children and paid for entirely by the employees does not
result in income to the employees under Treas. Reg. § 1.61-2(d)(2)(ii)(b) or is
excludable as a de minimis fringe benefit under section 132(e).1 The premium rate for
coverage in the face amount of $10,000 per child, paid entirely by the employees, is a
flat rate regardless of the number of children. Some employees with fewer children pay
more than the uniform rates in Table I of Treas. Reg. § 1.79-3(d)(2), and some
employees with more children pay less than the uniform rates. As set forth below,
those employees who pay more than the uniform rates in Table I of Treas. Reg.
§ 1.79-3(d)(2) will have no income. However, for those employees who pay less than
the uniform rates, we decline to issue a broad ruling on whether the insurance coverage
qualifies as a de minimis fringe, as this is essentially an issue of fact, and the value of
the dependent coverage received will be different for each individual employee,
depending on the number of children covered. However, we offer the following
guidance on how the taxpayer can determine whether the coverage will result in income
to its employees.

       Section 132(e) of the Code defines the term “de minimis fringe” as any property
or service the value of which is (after taking into account the frequency with which
similar fringes are provided by the employer to the employer’s employees) so small as
to make accounting for it unreasonable or administratively impracticable. Generally, the
frequency with which similar fringes are provided by the employer to the employer’s
employees is determined by reference to the frequency with which the employer
provides the fringes to each individual employee. Treas. Reg. §1.132-6(b).

       Pursuant to Notice 89-110, 1989-2 C.B. 447, if the face amount of employer-
provided group term life insurance payable on the death of a spouse or dependent of
an employee does not exceed $2,000, such insurance shall be deemed to be a de


       1
         Treas. Reg. §1.132-6(e)(2) provides that the cost of employer-provided group
term life insurance on the life of the spouse or dependent of an employee is not
excludible from gross income as a de minimis fringe. However, the effective date of
this provision as it relates to such insurance has been postponed until further notice.
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minimis fringe benefit under section 132(e). In determining whether employer-provided
dependent group term life insurance with a higher face amount is a de minimis fringe
benefit, only the excess (if any) of the cost of such insurance over the amount paid for
the insurance by the employee on an after-tax basis shall be taken into account. The
cost of the insurance shall be determined under Treas. Reg. §1.79-3(d)(2).

       In the instant case, the dependent coverage has a face amount of $10,000 per
child. The employees all pay the same flat rate for such coverage, regardless of the
number of children covered. Inasmuch as the amount of the insurance exceeds
$2,000, in determining whether the dependent coverage is a de minimis fringe benefit,
the taxpayer must consider the excess (if any) of the cost of such insurance to each
employee over the amount paid for the insurance by each employee on an after-tax
basis. Using this approach, those employees who pay more than the cost of the
uniform rates in Table I of Treas. Reg. §1.79-3(d)(2) will have no income.

                                        RULINGS

        1. Company may elect, for purposes of section 79 of the Code, to treat the
group term life insurance provided to its employees under its basic policy as a separate
policy from its supplemental policy.

       2. Company may elect, for purposes of section 79 of the Code, to treat the life
insurance offered to its smoking employees as a separate policy from the insurance
offered to its nonsmoking employees. As a result, no income will be imputed to the
Company's employees because of the supplemental coverage.

      3. The difference between the “cost” of the spousal coverage (as determined
under Treas. Reg. §1.79-3(d)(2)) and the amount paid by an employee for the
insurance is includible in the employee’s gross income.

       4. In determining whether the dependent coverage is a de minimis fringe
benefit, the taxpayer must consider the excess (if any) of the cost of such insurance to
each employee over the amount paid for the insurance by each employee on an after-
tax basis.

        No ruling has been requested and no opinion is expressed as to whether the
Company's basic coverage qualifies under section 79 of the Code. Moreover, no
opinion is expressed as to the tax treatment of the transaction under the provisions of
any other section of the Code, or to the tax effects resulting from the transaction which
are not specifically covered by the above rulings.

       A copy of this letter should be attached to the Company's next federal income
tax return. A copy is provided for that purpose.
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      This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of
the Code provides that it may not be used or cited as precedent.

                                                Sincerely,



                                                James L. Brokaw
                                                Chief, Exempt Organizations Branch 1
                                                Office of Division Counsel/
                                                 Associate Chief Counsel
                                                 (Tax Exempt and Government Entities)


Enclosures:
 Copy for section 6110 purposes
 Copy of this letter