Publication 15-B Employer'S Tax Guide To Fringe Benefits

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The IRS will not enforce the application of social secur-

Insurance provided under a policy that provides a

permanent benefit (an economic value that extends

ity, Medicare, and FUTA taxes at the time of exercise on

beyond one policy year, such as paid-up or cash

the spread on incentive stock options and employee stock

surrender value), unless certain requirements are

purchase plan options until further guidance is issued. In

met. See Regulations section 1.79-1 for details.

addition, if stock acquired pursuant to the exercise of an

incentive stock option or employee stock purchase plan

option is subsequently sold in a disqualifying disposition,

Employee. For this exclusion, treat the following individu-

the income is not subject to income tax withholding. (How-

als as employees.

ever, the income should be reported to the employee or

1) A current common-law employee.

former employee, generally in box 1 of Form W-2.) See

Notice 2002-47 for more information. You can find Notice

2) A full-time life insurance agent who is a current statu-

2002-47 on page 97 of Internal Revenue Bulletin 2002-28

tory employee.

3) An individual who was formerly your employee under

An employee who transfers his or her interest in non-

(1) or (2), above.

statutory stock options to the employee’s former spouse

4) A leased employee who has provided services to

incident to a divorce is not required to include an amount in

you on a substantially full-time basis for at least a

gross income upon the transfer. The former spouse, rather

year if the services are performed under your pri-

than the employee, is required to include an amount in

mary direction and control.

gross income when the former spouse exercises the stock

options. See Revenue Ruling 2002-22 for details. You can

Exception for S corporation shareholders. Do not

find Revenue Ruling 2002-22 on page 849 of Internal

treat a 2% shareholder of an S corporation as an employee

Revenue Bulletin 2002-19 at

of the corporation. A 2% shareholder is someone who

irb02-19.pdf.

directly or indirectly owns (at any time during the year)

For more information about employee stock options,

more than 2% of the corporation’s stock or stock with more

see sections 421, 422, and 423 of the Internal Revenue

than 2% of the voting power.

Code and their related regulations.

The 10-employee rule. Generally, life insurance is not

group-term life insurance unless you provide it to at least

Group-Term Life Insurance Coverage

10 full-time employees at some time during the year.

For this rule, count employees who choose not to re-

This exclusion applies to life insurance coverage that

ceive the insurance unless, to receive it, they must contrib-

meets all of the following conditions.

ute to the cost of benefits other than the group-term life

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It provides a general death benefit that is not in-

insurance. For example, count an employee who could

cluded in income.

receive insurance by paying part of the cost, even if that

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employee chooses not to receive it. However, do not count

You provide it to a group of employees. See The

an employee who must pay part or all of the cost of

10-employee rule below.

permanent benefits to get insurance, unless that employee

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It provides an amount of insurance to each em-

chooses to receive it.

ployee based on a formula that prevents individual

Exceptions. Even if you do not meet the 10-employee

selection. This formula must use factors such as the

rule, two exceptions allow you to treat insurance as

employee’s age, years of service, pay, or position.

group-term life insurance.

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You provide it under a policy that you carry directly

Under the first exception, you do not have to meet the

10-employee rule if all of the following conditions are met.

or indirectly. Even if you do not pay any of the

policy’s cost, you are considered to carry it if you

1) If evidence that the employee is insurable is re-

arrange for payment of its cost by your employees

quired, it is limited to a medical questionnaire (com-

and charge at least one employee less than, and at

pleted by the employee) that does not require a

least one other employee more than, the cost of his

physical.

or her insurance. Determine the cost of the insur-

2) You provide the insurance to all of your full-time

ance, for this purpose, as explained under Cover-

employees or, if the insurer requires the evidence

age over the limit on page 10.

mentioned in (1), to all full-time employees who pro-

vide evidence the insurer accepts.

Group-term life insurance does not include the following

insurance.

3) You figure the coverage based on either a uniform

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percentage of pay or the insurer’s coverage brack-

Insurance that does not provide general death bene-

ets.

fits, such as travel insurance or a policy providing

only accidental death benefits.

Under the second exception, you do not have to meet

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the 10-employee rule if all of the following conditions are

Life insurance on the life of your employee’s spouse

met.

or dependent. However, you may be able to exclude

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the cost of this insurance from the employee’s

You provide the insurance under a common plan

wages as a de minimis benefit. See De Minimis

covering your employees and the employees of at

(Minimal) Benefits on page 6.

least one other employer that is not related to you.

Page 9

Publication 15-B Employer'S Tax Guide To Fringe Benefits - 2003 Page 9

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