255 / What are the tax consequences of dividends paid to an employee under a policy that provides both permanent benefits and group term life insurance?
If an employee pays nothing toward the cost of permanent benefits, all dividends under a policy that actually are received or that are constructively received by an employee are includable in the employee’s income.1
If an employee pays a part or all of the cost of the permanent benefits, the amount of dividends includable by the employee is determined under this formula: (D + C) – (PI + DI + AP), where D equals the total dividends received by the employee in the employee’s current and all preceding taxable years; C equals the total cost of permanent benefits for the employee’s current and all preceding tax years, using the formula in Q 254; PI equals the total premium included in the employee’s income under the formula in Q 189 for the employee’s current and all preceding tax years; DI equals the total amount of dividends included in the employee’s income under the formula in this answer for all preceding tax years of the employee; and AP equals the total amount paid for the permanent benefits by the employee in the current and all preceding tax years of the employee.2 It appears that an employee who pays no more than allocated cost will be taxed under the formula on the amount of dividends the employee receives.
1. Treas. Reg. § 1.79-1(d)(5).