Section 79 plan
Section 79 of the Internal Revenue Code means the tax consequences and requirements for corporations wanting to install a group-term life insurance plan. Permanent life insurance plans is also offered as an added benefit in a Section 79 plan. Section 79 plans are non-qualified as defined by the Internal Revenue Code, but still offer a tax deductions for sponsoring employers.
Employees that are participating in Section 79 plan offered by a sponsoring corporation may receive up to $50,000 in group term life insurance, if it is non-discriminatory then they will receive it at no cost . Any amount over this limit is said to be a ‘permanent benefit’. The employee should realize a portion of the permanent benefit as W-2 taxable income, and pay any applicable taxes accordingly. Contributions to a Section 79 plan are tax-deductible, though for owner(s), and 2% or more shareholders, contributions are only deductible if paid by, and from, a C Corporation.
Although the available number of insurance companies that sell a Section 79 permanent product may be limited, a Section 79 benefit program may allow the following benefits.
- To purchase permanent life insurance with corporate dollars
- Deduct all of the cost to the C corporation as a business expense
- Allow the transfer of corporate dollars to the business owner on a tax-favored basis
- Grow the money in the plan in a tax-deferred setting
- Access to money in the plan can be achieved through policy loans on a tax-deferred basis
- Death benefits can pass to heirs on an income tax-free basis.
- There are no regulatory limits on funding for the key participants
- May provide asset protection by removing plan assets from the reach of company creditors
- Provides for minimal rank and file employee cost
- Insurance cash values may provide tax-free income as long as the policy is kept in force and withdrawals do not exceed the cost basis
A section 79 plan may be used for the following applications:
- Group life insurance benefits
- Deductible insurance to fund estate planning needs of the business owner
- Deductible insurance to provide personal life insurance needs for the owner
- Deductible insurance to fund a buy-sell agreement or key man policy
- Future business buyout on a tax-advantaged basis
Determining the death benefit
Death benefits can be determined by different methods at the discretion of the employee: from a minimum coverage of group term insurance to a permanent benefit up to a pre-determined employee’s reported W-2 income. The tax consequences and funding commitment to the employee will impact from the moment that they choose within the plan. In the case of an employee making $245,000, if a 10× multiple is used, that employee will receive a death benefit equal to $2,450,000 ($245,000 × 10). The resulting contribution depends heavily on what product is being used for funding, as well as the employee’s age and health.
Calculating the tax liability
In a non-discriminatory Section 79 plan the first $50,000 of coverage is provided free to all employees. Any group coverage over this amount is considered as a benefit for which the employee must pay. The pure insurance portion is factored using the IRS’s published Table I rates. If using permanent insurance the portion was calculated as the ‘permanent benefit’ takes into account premium(s) paid, accumulated and cash surrender value, and other policy factors
There are generally four main requirements which must be met when installing a Section 79 plan:
- The plan must provide a death benefit excludable from income under Code section 101(a)
- Must be provided to a group of employees
- Must be provided under a policy carried directly or indirectly by the employer
- Maximum death benefits for each employee based on a multiple of compensation
In order for a Section 79 plan to maintain its non-discriminatory form other requirements must be met:
- Cover at least 70% of employees
- No more than 15% of the participants are key employees
- Benefits based on reasonable classifications
It is possible to have what is said to be a discriminatory Section 79 plan. Under a discriminatory plan the first $50,000 of death benefit coverage is not free for owners and key employees. Cost will again be based on the IRS Table I rates. Rank and file employees maintain their free benefit whether or not the plan is discriminatory.
There are another set of requirements comes if the company has less than 10 employees.
Under 10 employees
- Employees with less than six months of full-time employment may be excluded
- Benefits must be based on a uniform percentage of compensation or coverage brackets, such that no bracket is more than 2.5 times the next lowest bracket and the lowest bracket is at least 10% of the highest bracket
With 10 or more employees
- Employees with less than 36 months of full-time employment may be excluded
- Employees under the age of 18 or over the age of 64
- Part-time or seasonal employees
- Employees covered under a union contract, provided the group term life insurance benefits were the subject of good faith bargaining
- Anyone not medically approved
- Anyone choosing to opt out
Coverage for spouses and dependents
The cost of employer,if it is a group-term life insurance on the life of an employee’s spouse or dependent, if it was paid by the employer, is not taxable to the employee if the face amount of the coverage does not exceed $2,000. This coverage is excluded as a de minimis fringe benefit. Some cases may allow more.