A fringe benefit primer for the closely held C corporation.

• Author: Altieri, Mark P.
• Position: Part 2

In many circumstances, key employees of closely held C corporations can be compensated with salary and other benefits not granted proportionately or equivalently to other employees. Part I of this article, in the October 2004 issue, examined salaries and bonuses, interest-free loans and health and disability insurance. Part II, below, discusses the characteristics, advantages and disadvantages of group-term life insurance, split-dollar life insurance and nonqualified deferred compensation.

Group-Term Life Insurance

Employers and key employees should normally consider group-term life insurance as an insurance option, because the premiums are generally fully deductible by the employer and partially or fully excludible by the employee. Although the employer's premium is deductible if reasonable, Sec. 79(a) excludes the cost of the first $50,000 of group-term coverage from an employee's gross income. The cost of insurance over $50,000 is taxed to the benefited employees under the so-called Table I rates in 1Legs. Sec. 1.79-3(d)(2). The imputed Table I cost is also extended to a retired employee. However, if a covered employee is disabled within the meaning of Sec. 72(m)(7), it is not imputed to him or her for post-termination coverage, under Sec. 72(b)(1).

The Sec. 79 imputed income provisions are extremely favorable to a benefited employee, because (except for a discriminatory group-term plan, discussed below) the maximum imputed income to a retiree over age 70 equals that imputed to a 70-year-old employee. This is often less than the actual premium spent by a company for the retired employee's benefit.

The proceeds payable on an insured's death under a group-term life insurance plan are excluded from a beneficiary's gross income under Sec. 101(a). Additionally, group-term insurance is individually owned. Thus, if a particular contract can be assigned under state law and the insured employee retains no incidents of ownership under Sec. 2042, the death proceeds may be excluded from his or her gross estate, as well.

Plan Requirements

The requirements for structuring a group-term life insurance plan are found in the Sec. 79 regulations. To qualify under Regs. Sec. 1.79-0, coverage must be through a term insurance policy (or policies) and must be purchased for a group of common-law employees. Generally, under Regs. Sec. 1.79-0 and -1(a)(2), the covered group must include all employees; if fewer than all employees are covered, the group's membership must be determined solely on the basis of age, marital status or factors related to employment. For groups of 10 or more covered employees, Regs. Sec. 1.79-19(a)(4) requires membership to be conditioned on the nature of duties, the compensation level, the length of service or other employment-related factors.

Under Regs. Sec. 1.79-1 (c), groups of fewer than 10 employees must include all employees, with the exception of (1) part-time employees (i.e., those whose customary work week does not exceed 20 hours or five months in a calendar year), (2) employees with less than six months of employment and (3) employees who have attained age 65. There can be no individual evidence of insurability other than a medical questionnaire that does not require a physical examination.

Nondiscrimination Rules

A group-term plan that does not meet Sec. 79(d)'s nondiscrimination standards, but otherwise meets the general requirements of group-term life insurance just noted, retains few tax advantages for a key employee. Sec. 79(d)(1) requires a key employee covered under a discriminatory group-term fife insurance plan to include in income the full premium spent by the employee for his or her coverage under the plan. Thus, a key employee under a discriminatory plan cannot exclude the cost of the first $50,000 of coverage. Also, he or she cannot use the generally favorable Table I rates for determining the economic benefit provided through the group-term coverage.

To comply with Sec. 79(d) non-discrimination requirements, a group-term plan must meet one of the following minimum participation rules (generally similar to those for qualified retirement plans):

* The plan must benefit at least 70% of all employees;

* Not more than 15% of all participants can be key employees;

* The plan must benefit a classification (determined by the Service) that does not discriminate in favor of key employees; or

* The plan must be part of a cafeteria plan that meets Sec. 125 requirements.

Sec. 79(d) also requires the plan not to discriminate in amount or type of available benefits; although, under Sec. 79(d)(5), the amount of insurance can bear a uniform relationship to compensation (e.g., coverage may equal one times salary and bonus). (28)

Thus, a corporation can establish a nondiscriminatory group-term life insurance plan for key employees that provides them with coverage in excess of that of nonkey employees, provided the coverage is proportionate to compensation paid to all covered employees. Additionally, under either a discriminatory or nondiscriminatory plan, a key employee may exclude all imputed cost under a group-term life insurance plan provided to him or her after disability. Lastly, if the group-term plan is nondiscriminatory, the Table I imputed cost to a covered retired employee will never exceed that applicable to a 70-year-old employee. If group-term coverage is provided to a retired key employee through a discriminatory group-term plan, such coverage will be included in that employee's income. Thus, a company that wants to offer key employees post-retirement coverage will have to maintain a nondiscriminatory group-term plan.

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