Section 79 plans offer more than just term insurance

Most small business owners and professionals are very familiar with group term life insurance programs, particularly those that offer up to $50,000 of term life insurance to employees. These programs, sanctioned by Section 79 of the Internal Revenue Code, also permit employers to provide additional amounts of term life insurance in excess of $50,000 to employees. To the extent that they do so, the employer must report the value of the excess coverage on the employee's W-2 as additional compensation. The value of this coverage for tax reporting purposes is determined under Table I of the Treasury Regulations, in the form of uniform premiums computed on the basis of five-year age brackets. So long as the employer is not directly or indirectly a beneficiary of the insurance, all employer contributions to the plan are currently deductible and the employee is not taxable on the first $50,000 of coverage.

Garry Thurman

What is less commonly known is that the same Section 79 permits a group term insurance plan to provide permanent benefits. The regulations define a "permanent benefit" as "an economic value extending beyond one policy year (for example, a paid-up or cash surrender value) that is provided under a life insurance policy." This is accomplished by using a permanent life insurance policy in the plan. When a Section 79 plan containing permanent benefits is adopted by an employer, there are several significant advantages:

* Generally, contributions to the plan are currently deductible to the business

* Only a portion of these amounts is includible in the participant's income

* Plan assets (in the form of life insurance policy cash values) accumulate tax-deferred

* In the event of the participant's death, an income tax-free survivor benefit is provided

* Benefits can be structured to avoid estate taxes

Once the plan is terminated, the participant has the option of accessing the cash value from the insurance policy using policy loans and withdrawals to the extent of the policy's cash value. (Policy loans and withdrawals reduce the policy's cash value and death benefit and may result in a taxable event. Surrender charges may reduce the policy's cash value in early years.)

Section 79(d) does contain non-discrimination rules as to eligibility and benefits. Certain types of employees can be excluded from consideration, such as employees who are covered by certain collective bargaining agreements, employees who have not completed three years of service, and part-time employees.

A plan is non-discriminatory as to benefits if "the type and amount of benefits available under the plan do not discriminate in favor of participants who are key employees." A well-designed plan requires that all eligible participants be offered the option to elect the same benefits offered to key employees (e.g., permanent benefits). Such a plan will also require that all employees be offered a non-discriminatory amount of benefits, often by mandating that all participants shall be offered life insurance in an amount that represents a uniform percentage or multiple of W-2 compensation.

Because the options available to eligible employees that involve coverage in excess of $50,000 of term insurance will result in an increase in the employee's gross income and generally an increase in the employee's income tax liability employees are permitted to decline coverage in excess of $50,000.

Employees who do elect to receive permanent benefits must include the value of the permanent benefits in their gross income, reduced by any amounts they contribute from their own funds for the permanent benefits. The actuarial formula for calculating the value of permanent benefits is set forth in the Treasury Regulations under Section 79 of the Internal Revenue Code, and is based on such factors as the age of the employee and the type of insurance contract used.

Section 79 plans are not for every business and require a C corporation, in which benefits are provided to owner employees. Your insurance professional and other advisors will help you determine eligibility. But for those closely held businesses and professional practices in which there is a fit, they provide valuable insurance and an exciting, tax-advantaged opportunity for both owners and their employees.

This information is not intended as tax or legal advice. Please consult with your attorney or accountant prior to acting upon any of the information contained in this article. The views and information contained herein have been prepared independently of the presenting representative and are presented for informational purposes only.

Noteworthy:

"The value of [group term life insurance] coverage for tax reporting purposes is determined under Table I of the Treasury Regulations, in the form of uniform premiums computed on the basis of five-year age brackets."