As Congress grapples with preventing the expiration of major Tax Cuts and Jobs Act (TCJA) provisions, it must identify revenue-raising measures that minimize economic harm. One often-overlooked opportunity is eliminating tax exclusions for employer-provided group-term life insurance.
The current tax system violates key principles of neutrality in two significant ways: it discriminates between different forms of employee compensation and between saving and consumption. Section 79 of the Internal Revenue Code exempts premiums paid by employers for the first $50,000 of life insurance coverage from employees’ taxable income. This exemption not only distorts employee compensation neutrality but also introduces a second layer of tax exemption on saving through life insurance.
The Issue with Current Tax Treatment
Life insurance serves as a form of saving where premiums are “invested” upfront, and benefits are paid out tax-free to beneficiaries upon death. Ideally, a neutral tax system would tax this saving only once – either at the time of investment or when benefits are paid out. Currently, death benefits are tax-free, and premiums for coverage up to $50,000 are also exempt from taxation, creating a double tax exemption. For coverage exceeding $50,000, employers report imputed income on employees’ W-2 forms based on IRS tables, not actual premiums or actuarial costs. This can lead to over-taxing or under-taxing due to the misalignment between imputed and actual costs.
Consequences of the Tax Exclusion
The tax exclusion disproportionately benefits higher-income taxpayers due to the progressive income tax structure. For instance, a taxpayer in the top marginal tax rate of 37% saves $37 in taxes for every $100 of excluded coverage, while a lower-income individual in the 10% bracket saves only $10. The Treasury Department estimates that maintaining this exclusion will cost nearly $45 billion over the next decade.
Proposed Solution
To improve tax neutrality and raise revenue, policymakers should repeal the exclusion for employer-provided group-term life insurance premiums and the associated imputed income rules. Ideally, the full value of premiums should be included in taxable income, reflecting the actual cost of insurance. This reform would contribute to a more equitable tax system while generating additional revenue.
By addressing these tax exclusions, Congress can move toward a more balanced and efficient tax code that supports both fiscal responsibility and economic growth.
