Imputed income is the recognization of a benefit received for which the recipient did not pay. When it comes to life insurance, imputed income occurs when someone receives coverage through his/her employer where the individual does not pay for the coverage. Internal Revenue Code 61 stipulates most of the rules for imputed income.
Imputed income is taxable income, but is not normally subject to tax withholdings. It is, however, subject to Social Security and Medicare Taxes (FICA) withholding. This means imputed income might create tax consequences like a decrease in the size of your tax refund or an increase in the size of the check you write to the IRS when filing your taxes.
What is Imputed Income on my Paycheck?
Employers will account for imputed income under box 1 on form W-2. You can normally identify receiving imputed income if you see box 12c on your W-2 filled in.
Two very common reasons to report imputed income are life insurance coverage over $50,000 and health insurance coverage provided to a non-marital spouse.
The imputed income becomes part of the employee's gross income for the year.
Why is Group-Term Life Insurance Coverage Over $50,000 Taxable?
A group term life insurance plan that an employer pays for or a plan where certain employees pay more for coverage and some less according to a specific table's rates (more on that in the next section) create imputed income for any death benefit in excess of $50,000.
IRC section 79 declares death benefit coverage under $50,000 a de minimis benefit.
The imputed income amount, in this case, is the cost of the insurance covered by the employer for this fringe benefit.
How is it Calculated?
Imputed income occurs when either your employer covers the entire cost of providing the life insurance coverage or the employer subsidizes the cost for some employees by charging other employees more for the coverage received versus what IRS Premium Table I reports as the cost for that age group. Subsidizing the cost of the life insurance policy for some participants in the plan against the premium table's rates is known as a straddle.
The imputed cost of coverage is the cost of providing the face amount of the coverage to the employee. Note: if the employer does not cover the cost of the group life insurance coverage and each employee pays his/her full cost of the insurance then no imputed income occurs.
Do I have to Pay Income Taxes on Imputed Income?
Yes, imputed income counts towards your ordinary income received from your employer and you will owe income taxes on the amount received.
The employer will handle the calculation for imputed income and report the income you received on your W-2 as part of your taxable wages. You'll be responsible for calculating the amount of Federal Income Tax you owe on it as well as your other income.
Can the IRS Take Life Insurance from Beneficiary?
The IRS does not necessarily take life insurance away from a beneficiary. However, if you do not pay taxes on the imputed income you receive through the taxable fringe benefit provided by your employer, it will make the entire amount of death benefit payable to your beneficiary taxable.
This is an extremely rare situation.
Health Insurance Imputed Income
Imputed income also occurs when you provide a domestic partner health insurance benefits. In this case, the imputed income is the cost of employer-subsidized premium. For example, if the health insurance plan has premium payments totaling $800 per month, but you pay $100 per month for the fringe benefit because your employer is subsidizing the remaining amount, you receive $700 per month in imputed income because the plan covers your domestic partner.