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

2) A group of employees defined under a reasonable

1) It provides a general death benefit that is not in-

classification you set up that does not favor highly

cluded in income.

compensated employees.

2) You provide it to a group of employees. See The

For this exclusion, a highly compensated employee for

10-employee rule, below.

2002 is an employee who meets either of the following

tests.

3) It provides an amount of insurance to each employee

based on a formula that prevents individual selec-

1) The employee was a 5% owner at any time during

tion. This formula must use factors such as the

the year or the preceding year.

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

2) The employee received more than $90,000 in pay for

4) You provide it under a policy you carry directly or

the preceding year.

indirectly. Even if you do not pay any of the policy’s

cost, you are considered to carry it if you arrange for

You can choose to ignore test (2) if the employee was not

payment of its cost by your employees and charge at

also in the top 20% of employees when ranked by pay for

least one employee less than, and at least one other

the preceding year.

employee more than, the cost of his or her insur-

ance. Determine the cost of the insurance, for this

purpose, as explained in the discussion on coverage

Employee Stock Options

over the limit under Exclusion from wages, on page

10.

There are three classes of stock options — incentive stock

Group-term life insurance does not include the following

options, employee stock purchase plan options, and non-

insurance.

qualified (nonstatutory) stock options.

•

Generally, for income tax purposes, incentive stock

Insurance that does not provide general death bene-

options and employee stock purchase plan options are

fits, such as travel insurance or a policy providing

excluded from wages both when the options are granted

only accidental death benefits.

and when they are exercised (unless the stock is disposed

•

Life insurance on the life of your employee’s spouse

of in a disqualifying disposition). However, the spread

or dependent. However, you may be able to exclude

(between the exercise price and fair market value of the

the cost of this insurance from the employee’s

stock at the time of exercise) is included in wages subject

wages as a de minimis benefit. See De Minimis

to social security, Medicare, and federal unemployment

(Minimal) Benefits, earlier.

taxes when the options are exercised. Income tax with-

•

holding is not required at the time of exercise.

Insurance provided under a policy that provides a

permanent benefit (an economic value that extends

The spread on nonqualified options normally is included

beyond 1 policy year, such as paid-up or cash sur-

in wages for income tax purposes when the options are

render value), unless certain requirements are met.

exercised. (See section 1.83-7 of the regulations.) The

See section 1.79-1(b) of the regulations for details.

spread on nonstatutory options is also subject to social

security, Medicare, and FUTA taxes, and income tax with-

holding at the time of exercise.

Employee. For this exclusion, treat the following individu-

The IRS will not enforce the application of social secur-

als as employees.

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

the spread on incentive stock options and employee stock

1) A current common-law employee.

purchase plan options, for exercises that occur before

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

January 1, 2003. In addition, if stock acquired pursuant to

tory employee.

the exercise of an incentive stock option or employee stock

purchase plan option that occurred before January 1,

3) An individual who was formerly your employee under

2003, is subsequently sold in a disqualifying disposition,

(1) or (2), above.

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

4) A leased employee who has provided services to

ever, the income should be reported to the employee or

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

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

year if the services are performed under your pri-

Notice 2001-14 (2001-16 I.R.B. 516) for more information.

mary direction and control.

For more information about employee stock options,

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

Exception for S corporation shareholders. Do not

Code and the related regulations.

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

of the corporation. A 2% shareholder is someone who

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

Group-Term Life

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

than 2% of the voting power.

Insurance Coverage

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

This exclusion applies to life insurance coverage that

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

meets all the following conditions.

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

Page 9

Publication 15 B - Employer'S Tax Guide To Fringe Benefits - 2002 Page 9

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