3973 / How is an employee’s cost basis determined for an interest in a qualified plan?
An employee normally will have no cost basis if a plan is noncontributory and does not provide life insurance protection.
If life insurance protection has been provided under a cash value policy, the employee usually will have some cost basis, namely, the aggregate one year term costs that have been taxed to the employee, even though the plan is noncontributory.1
A self-employed person who is an owner-employee cannot include in his or her cost basis the annual one year costs of life insurance protection under Table 2001 or previously under P.S. 58 ( Q 3948), even though these costs were not deductible.2 No self-employed person, whether or not an owner-employee, can include in cost basis the cost of any health insurance features under the plan.
A common law employee’s cost basis consists of:
(1) total nondeductible contributions made by the employee if the plan is contributory and amounts contributed by an S corporation for years beginning before January 1, 1984, on behalf of a more-than-5-percent shareholder-employee in excess of the excludable amount;
(2) the sum of the annual one year term costs of life insurance protection under Table 2001 or previously P.S. 58 ( Q 3948) that have been includable as taxable income if payment is being received under the contract that provided the life insurance protection( Q 3952);
(3) any other employer contributions other than excess deferrals ( Q 3760) that already have been taxed to the employee, such as where a nonqualified plan was later qualified;
(4) certain employer contributions attributable to foreign services performed before 1963; and
(5) the amount of any loans included in income as taxable distributions ( Q 3953).
In addition, although amounts attributable to deductible employee contributions are not part of basis, it would seem they should be included in basis if benefits are received under the contract to the extent that they have been taxable to the employee because they were used to purchase a life insurance contract ( Q 3952). This cost basis must be reduced by any amounts previously distributed to the employee that were excludable from gross income as a return of all or part of the employee’s basis.3
A self-employed person’s cost basis consists of (1) the nondeductible 50 percent of contributions made before 1968, after subtracting the cost of incidental benefits, if any, such as waiver of premium and health insurance benefits, and, in the case of an owner-employee, the costs of life insurance protection under Table 2001 or previously P.S. 58 ( Q 3948), (2) contributions on behalf of owner-employees under the three year average rule for determining contributions to level premium insurance and annuity contracts in excess of the deductible limit, in effect for years beginning before 1984, and (3) nondeductible voluntary contributions, if any, to a contributory plan.
In addition, any amounts taxed to an individual because they were attributable to deductible voluntary employee contributions used to purchase life insurance, if benefits are received under the contract, probably should be included.