Year-End Benefit Planning and Accounting Treatment

A '79 group benefit plan has funding and timing opportunities similar to qualified plans without the added expenses and discrimination testing of '401(a)-type plans. The reporting at the employer level is less complex and draconian. The difference is due to the fact that the group term life segment payment (from an accounting standpoint) should be treated like a group term life insurance premium payment, i.e., the full premium payment should be shown as an expense each year. Nevertheless, as with all accounting issues, it is up to the employer's accountant to interpret FASB statements and opinions, and make the final decision as to how individual transactions are reflected on the employer's financial statements.

Group Term Life Insurance

The accounting for the group term life premium is straightforward. The group term life premium would be shown as an expense on the employer's income statement. Since the group term life premium represents the cost of the death benefit and does not increase the cash value, the accounting treatment should be the same as a group term life insurance policy. The journal entry below is an example of how an employer would record the payment of the group term life premium (e.g., where the premium is $85,000, total premium is $100,000). Although account titles will vary from employer to employer, since the employer is not the beneficiary of the group term life death benefit, the account title for the expense should reflect that the expense was incurred for an employee benefit. An account title such as “Expense ' life insurance” may be misleading since this is a title often used for key person insurance, where the employer is the beneficiary of the policy. Since the employer cannot be beneficiary of the group term life premium, an account title such as “Expense ' employee benefits” is more appropriate.

Expense ' Employee

Benefits $85,000

Cash $85,000

Recording the'Premium Payment

The journal entry for the group term life premium may change each year. The amount contributed, and thus recorded, is based on the amount that is actuarially certified each year. Though we do not expect drastic changes in this amount, the contribution may not be exactly the same from year-to-year.

Where the employer retains ownership of the death benefits upon the retirement or withdrawal of an employee, the employer will be paying a nondeductible amount of the premium. Where the departing employee retains the policy, the supplemental funding premium will be paid by the employee and deductible at the employer level and taxable to the covered employee. If this method is used, the contributions by the employee will reduce dollar per dollar the Table I economic benefit to the participant for both income and transfer tax purposes. (Treas. Reg. 1.79-1(b)(5).)

If the employer retains the ownership upon retirement or withdrawal the supplemental funding premium payment is not a payment for group term life benefits for covered employees and therefore is not deductible. The accounting treatment for the supplemental funding premium should more closely resemble how a regular key person permanent policy is handled under Financial Accounting Standards Board (FASB) Technical Bulletin (TB) 85-4 and EITF 06-05.

The accounting treatment for a permanent cash value life insurance policy falls under TB 85-4, where a corporation is the owner and beneficiary of the policy. This particular technical bulletin requires that a business purchasing cash value life insurance use the cash surrender value method in accounting for the life insurance policy. Under the cash surrender value method, an asset account is increased each year by the increase in the cash surrender value over the premium payment for the policy. Every year that the policy is kept in force, the employer's balance sheet (typically under the category “Long-term assets/investments”) will include an account for “cash value life insurance.”

The employer, as owner of the policy, pursuant to the terms of a co-ownership agreement, may borrow from the policy and cannot surrender it as long as the employer is a participant in the plan. Because the employer owns the policy, the cash may be an asset of the employer. (See , TB 85-4 supra)

Continuing the $100,000 total premium example above, the journal entries for the supplemental funding premium payment would be as shown below. Assume a total supplemental funding premium payment of $15,000, where the cash value increase at the end of the first year is $1,000.

End of Year 1:

Asset ' Ownership Interest in Life Insurance $ 1,000

Expense ' Life Insurance $14,000

Cash $15,000

To record the cash value increase and the supplemental funding premium payment.

By the end of year 5, assume that the cash value increase every year is greater than the premium expense, as shown below:

End of year 5:

Expense ' Employee Benefits $85,000

Cash $85,000

To record the group term life premium payment.

Asset ' Ownership Interest in Life Insurance $20,000

Revenue $5,000

Cash $15,000

To record the cash value increase and supplemental funding premium payment.

The cash value account in Year 1 and Year 5 are shown on hypothetical Balance Sheets below.

[IMGCAP(1)]

When Must Funding'Take Place?

Under Secs. 461(h)(1) and (4), accrual-method taxpayers record revenue and expenses when all three of the following have occurred:

1. All events have occurred that establish the fact of the transaction;
2. The amount of the transaction can be determined with reasonable accuracy; and
3. Economic performance has occurred.

Sec. 461(h)(3) provides a recurring-item exception for the economic performance test. An item is treated as incurred during the tax year if all events with respect to the item have been met; economic performance occurs within the shorter of: 1) a reasonable period; or 2) eight-and-a-half months after the close of the tax year; the item is recurring in nature; and it is either not a material item or the accrual in the tax year provides a better matching of income and expenses.

Accrued Compensation and Benefits

When an accrual-method taxpayer accrues expenses related to a plan, method or arrangement (i.e., salary, vacation, commissions and management fees), these amounts will ordinarily not be deductible for income tax purposes and must be added back to arrive at taxable income on Schedule M-1. However, Temp. Regs. Sec. 1.404(b)-1T, Q&A-2, provides an exception if these amounts are paid to employees within two and-a-half months of the end of the tax year. Where an existing group term life plan is amended and the Table I is reported for all covered employees, that matches the providing of benefit to permit the benefit to accrue in the year the Table I applies. Where an employer has an existing group term life program and increases the death benefit by an amendment to the plan, the coverage should relate back to the previous accounting period, as long as the funding occurs within the two-and-a-half months of the close of the accounting period.

On Dec. 13, 2011, the IRS released Rev. Rul. 2012-1, which addresses the application of the economic performance rules and whether the recurring-item exception may be applied to accelerate economic performance. The determination of when economic performance occurs is a key factor in determining when a liability is properly taken into account under Sec. 461 and Regs. Sec. 1.461-1(a)(2)(i).

Background

In general, a taxpayer is allowed a deduction for an otherwise deductible expense in the period in which the following three-prong test (the first two prongs of which are referred to collectively as the “all-events test”) is met:

All events have occurred that determine the fact of the liability; The amount of the liability can be determined with reasonable accuracy; and economic performance has occurred with respect to the liability. (Regs. Sec. 1.461-1(a)(2)(i).)

The all-events test is met when: 1) the event fixing the liability occurs (whether the event is the required performance or another event); or 2) payment is due, whichever happens earlier (see, e.g., Rev. Rul. 2007-3).

In general, economic performance occurs for a liability arising out of the provision of property or services to the taxpayer by another person, as the property or services are provided. (Regs. Sec. 1.461-4(d)(2).) For liabilities arising out of the provision to the taxpayer of insurance or a warranty or service contract, economic performance occurs as payment is made to the person to whom the liability is owed. (Regs. Sec. 1.461-4(g)(5).)

The recurring-item exception of Sec. 461(h) and Regs. Sec. 1.461-5 provides an exception to the general rules of economic performance. If a taxpayer is eligible to use the recurring-item exception for a particular liability, then economic performance will be deemed to occur at year end. The recurring-item exception may be used if:

1. The all-events test has been met;
2. The liability is recurring in nature;
3. Economic performance occurs within eight-and-a-half months of year end; and
4. The amount of the liability ' in the earlier year results in a better matching of the liability with the income to which it relates.

These approaches should permit the deduction to be reflected the year the benefit program is implemented.

Lawrence L. Bell, JD, LTM, CLU, ChFC, CFP', AEP, a member of this newsletter's Board of Editors, has served as Tax Bar liaison to the IRS for 10 years. He has received patents in actuarial product fields dealing with COLI, GASB, FASB, IASB and OPEB solutions. He authors articles and speaks nationally about Decision Trees on COLI Best Practices, 409A and Benefit Planning. Stanley Hodge Jr. specializes in working with businesses, nonprofits and Taft Hartley plans. Before entering the financial services world, Hodge played professional basketball. He continues to assist aspiring young men and women to expand their opportunities.

A '79 group benefit plan has funding and timing opportunities similar to qualified plans without the added expenses and discrimination testing of '401(a)-type plans. The reporting at the employer level is less complex and draconian. The difference is due to the fact that the group term life segment payment (from an accounting standpoint) should be treated like a group term life insurance premium payment, i.e., the full premium payment should be shown as an expense each year. Nevertheless, as with all accounting issues, it is up to the employer's accountant to interpret FASB statements and opinions, and make the final decision as to how individual transactions are reflected on the employer's financial statements.

Group Term Life Insurance

The accounting for the group term life premium is straightforward. The group term life premium would be shown as an expense on the employer's income statement. Since the group term life premium represents the cost of the death benefit and does not increase the cash value, the accounting treatment should be the same as a group term life insurance policy. The journal entry below is an example of how an employer would record the payment of the group term life premium (e.g., where the premium is $85,000, total premium is $100,000). Although account titles will vary from employer to employer, since the employer is not the beneficiary of the group term life death benefit, the account title for the expense should reflect that the expense was incurred for an employee benefit. An account title such as “Expense ' life insurance” may be misleading since this is a title often used for key person insurance, where the employer is the beneficiary of the policy. Since the employer cannot be beneficiary of the group term life premium, an account title such as “Expense ' employee benefits” is more appropriate.

Expense ' Employee

Benefits $85,000

Cash $85,000

Recording the'Premium Payment

The journal entry for the group term life premium may change each year. The amount contributed, and thus recorded, is based on the amount that is actuarially certified each year. Though we do not expect drastic changes in this amount, the contribution may not be exactly the same from year-to-year.

Where the employer retains ownership of the death benefits upon the retirement or withdrawal of an employee, the employer will be paying a nondeductible amount of the premium. Where the departing employee retains the policy, the supplemental funding premium will be paid by the employee and deductible at the employer level and taxable to the covered employee. If this method is used, the contributions by the employee will reduce dollar per dollar the Table I economic benefit to the participant for both income and transfer tax purposes. (Treas. Reg. 1.79-1(b)(5).)

If the employer retains the ownership upon retirement or withdrawal the supplemental funding premium payment is not a payment for group term life benefits for covered employees and therefore is not deductible. The accounting treatment for the supplemental funding premium should more closely resemble how a regular key person permanent policy is handled under Financial Accounting Standards Board (FASB) Technical Bulletin (TB) 85-4 and EITF 06-05.

The accounting treatment for a permanent cash value life insurance policy falls under TB 85-4, where a corporation is the owner and beneficiary of the policy. This particular technical bulletin requires that a business purchasing cash value life insurance use the cash surrender value method in accounting for the life insurance policy. Under the cash surrender value method, an asset account is increased each year by the increase in the cash surrender value over the premium payment for the policy. Every year that the policy is kept in force, the employer's balance sheet (typically under the category “Long-term assets/investments”) will include an account for “cash value life insurance.”

The employer, as owner of the policy, pursuant to the terms of a co-ownership agreement, may borrow from the policy and cannot surrender it as long as the employer is a participant in the plan. Because the employer owns the policy, the cash may be an asset of the employer. (See , TB 85-4 supra)

Continuing the $100,000 total premium example above, the journal entries for the supplemental funding premium payment would be as shown below. Assume a total supplemental funding premium payment of $15,000, where the cash value increase at the end of the first year is $1,000.

End of Year 1:

Asset ' Ownership Interest in Life Insurance $ 1,000

Expense ' Life Insurance $14,000

Cash $15,000

To record the cash value increase and the supplemental funding premium payment.

By the end of year 5, assume that the cash value increase every year is greater than the premium expense, as shown below:

End of year 5:

Expense ' Employee Benefits $85,000

Cash $85,000

To record the group term life premium payment.

Asset ' Ownership Interest in Life Insurance $20,000

Revenue $5,000

Cash $15,000

To record the cash value increase and supplemental funding premium payment.

The cash value account in Year 1 and Year 5 are shown on hypothetical Balance Sheets below.

[IMGCAP(1)]

When Must Funding'Take Place?

Under Secs. 461(h)(1) and (4), accrual-method taxpayers record revenue and expenses when all three of the following have occurred:

1. All events have occurred that establish the fact of the transaction;
2. The amount of the transaction can be determined with reasonable accuracy; and
3. Economic performance has occurred.

Sec. 461(h)(3) provides a recurring-item exception for the economic performance test. An item is treated as incurred during the tax year if all events with respect to the item have been met; economic performance occurs within the shorter of: 1) a reasonable period; or 2) eight-and-a-half months after the close of the tax year; the item is recurring in nature; and it is either not a material item or the accrual in the tax year provides a better matching of income and expenses.

Accrued Compensation and Benefits

When an accrual-method taxpayer accrues expenses related to a plan, method or arrangement (i.e., salary, vacation, commissions and management fees), these amounts will ordinarily not be deductible for income tax purposes and must be added back to arrive at taxable income on Schedule M-1. However, Temp. Regs. Sec. 1.404(b)-1T, Q&A-2, provides an exception if these amounts are paid to employees within two and-a-half months of the end of the tax year. Where an existing group term life plan is amended and the Table I is reported for all covered employees, that matches the providing of benefit to permit the benefit to accrue in the year the Table I applies. Where an employer has an existing group term life program and increases the death benefit by an amendment to the plan, the coverage should relate back to the previous accounting period, as long as the funding occurs within the two-and-a-half months of the close of the accounting period.

On Dec. 13, 2011, the IRS released Rev. Rul. 2012-1, which addresses the application of the economic performance rules and whether the recurring-item exception may be applied to accelerate economic performance. The determination of when economic performance occurs is a key factor in determining when a liability is properly taken into account under Sec. 461 and Regs. Sec. 1.461-1(a)(2)(i).

Background

In general, a taxpayer is allowed a deduction for an otherwise deductible expense in the period in which the following three-prong test (the first two prongs of which are referred to collectively as the “all-events test”) is met:

All events have occurred that determine the fact of the liability; The amount of the liability can be determined with reasonable accuracy; and economic performance has occurred with respect to the liability. (Regs. Sec. 1.461-1(a)(2)(i).)

The all-events test is met when: 1) the event fixing the liability occurs (whether the event is the required performance or another event); or 2) payment is due, whichever happens earlier (see, e.g., Rev. Rul. 2007-3).

In general, economic performance occurs for a liability arising out of the provision of property or services to the taxpayer by another person, as the property or services are provided. (Regs. Sec. 1.461-4(d)(2).) For liabilities arising out of the provision to the taxpayer of insurance or a warranty or service contract, economic performance occurs as payment is made to the person to whom the liability is owed. (Regs. Sec. 1.461-4(g)(5).)

The recurring-item exception of Sec. 461(h) and Regs. Sec. 1.461-5 provides an exception to the general rules of economic performance. If a taxpayer is eligible to use the recurring-item exception for a particular liability, then economic performance will be deemed to occur at year end. The recurring-item exception may be used if:

1. The all-events test has been met;
2. The liability is recurring in nature;
3. Economic performance occurs within eight-and-a-half months of year end; and
4. The amount of the liability ' in the earlier year results in a better matching of the liability with the income to which it relates.

These approaches should permit the deduction to be reflected the year the benefit program is implemented.

Lawrence L. Bell, JD, LTM, CLU, ChFC, CFP', AEP, a member of this newsletter's Board of Editors, has served as Tax Bar liaison to the IRS for 10 years. He has received patents in actuarial product fields dealing with COLI, GASB, FASB, IASB and OPEB solutions. He authors articles and speaks nationally about Decision Trees on COLI Best Practices, 409A and Benefit Planning. Stanley Hodge Jr. specializes in working with businesses, nonprofits and Taft Hartley plans. Before entering the financial services world, Hodge played professional basketball. He continues to assist aspiring young men and women to expand their opportunities.