Employee Death Benefits

March 13, 2024

3638 / If an employer is under contract to pay a death benefit to an employee’s surviving spouse, is the benefit taxable income to the surviving spouse?

<div class="Section1">Yes. Death benefits payable under a contract, or pursuant to an established plan of the employer (usually referred to as a “death benefit only” plan), are taxable income, and for this reason are frequently paid in installments.<a href="#_ftn1" name="_ftnref1">1</a> Employee death benefits that are payable by reason of the death of certain terrorist attack victims or astronauts are excludable from gross income.<a href="#_ftn2" name="_ftnref2">2</a><div class="Section1"> Frequently, death benefits are funded by insurance on the life of the employee, with the insurance owned by and payable to the employer (traditional key associate life insurance). The fact that the death payments originate from life insurance proceeds received tax-free by the employer does not cause them to be tax-exempt to the employee’s surviving spouse. The surviving spouse receives them as compensation payments from the employer and not as life insurance proceeds.<a href="#_ftn3" name="_ftnref3">3</a> (For tax effects of insurance funding, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="262">262</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="263">263</a>, and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="276">276</a>.) Employee death benefits rarely qualify as life insurance benefits wholly excludable under IRC Section 101(a) ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="63">63</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="65">65</a>, and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="260">260</a>).<a href="#_ftn4" name="_ftnref4">4</a> Death benefits payable to an employee’s surviving spouse under a split dollar life insurance arrangement, however, may be received free of income tax obligations ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4022">4022</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4023">4023</a>). Contractual death benefits are “income in respect of a decedent.”<a href="#_ftn5" name="_ftnref5">5</a> Consequently, where an estate tax has been paid, the recipient of the death payments is entitled to an income tax deduction for that portion of the estate tax attributable to the value of the payments, which may not prove very valuable. <hr> Planning Point: For the reasons mentioned above -income taxation of the death benefit to the beneficiary and only a potential deduction to the estate – it is often more attractive to create an endorsement split dollar life insurance plan for an employee so that the death benefits will be treated as the proceeds of life insurance to the beneficiary. The trade-off is some annual current economic benefit to the employee. <hr> </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.   Simpson v. U.S., 261 F.2d 497 (7th Cir. 1958); Robinson v. Comm., 42 TC 403 (1964). <a href="#_ftnref2" name="_ftn2">2</a>.   IRC § 101(i). <a href="#_ftnref3" name="_ftn3">3</a>.   Essenfeld v. Comm., 311 F.2d 208 (2d Cir. 1962). <a href="#_ftnref4" name="_ftn4">4</a>.   See Edgar v. Comm., TC Memo 1979-524. <a href="#_ftnref5" name="_ftn5">5</a>.   Estate of Wright v. Comm., 336 F.2d 121 (2d Cir. 1964). </div></div>

March 13, 2024

3640 / If an employer voluntarily pays a death benefit to an employee’s surviving spouse, is the benefit taxable income to the surviving spouse, and is it deductible by the employer?

<div class="Section1">The IRS has taken the position that voluntary death benefits are not gifts, but are compensation and therefore taxable income.<a href="#_ftn1" name="_ftnref1">1</a> The courts, following the rules developed by the United States Supreme Court in Commissioner v. Duberstein,<a href="#_ftn2" name="_ftnref2">2</a> have divided on the question of whether these payments are tax-free gifts or taxable compensation. Each case has been decided on its facts.<a href="#_ftn3" name="_ftnref3">3</a></div> <div class="Section1"> Payments made after December 31, 1986 by an employer “to, or for the benefit of” an employee are not excludable as gifts, however.<a href="#_ftn4" name="_ftnref4">4</a> Thus, a death benefit paid by an employer after December 31, 1986 would appear to be a payment for the benefit of an employee and, if so, would be taxable compensation not an excludable gift. Employee death benefits that are payable by reason of the death of certain terrorist attack victims or astronauts are excludable from gross income.<a href="#_ftn5" name="_ftnref5">5</a> To be deductible by the employer, a voluntary death benefit must qualify as an ordinary and necessary business expense.<a href="#_ftn6" name="_ftnref6">6</a> Payments will be deductible, therefore, if the circumstances show that they are additional reasonable compensation for the employee’s services, or otherwise qualify as an ordinary and necessary business expense.<a href="#_ftn7" name="_ftnref7">7</a> The deduction will be denied if the facts indicate that the payment was purely a gift or was made for the personal satisfaction of the directors.<a href="#_ftn8" name="_ftnref8">8</a> Where the surviving spouse is a controlling stockholder, the payments may very likely be treated as constructive dividends. In such a case, the entire death benefit would be taxable to the surviving spouse but not deductible by the corporation.<a href="#_ftn9" name="_ftnref9">9</a> Even where the surviving spouse does not own a controlling interest, the payments may be treated as dividends, if the corporation is owned by a closely knit family group.<a href="#_ftn10" name="_ftnref10">10</a> The payments will not be treated as dividends merely because the employee was a minority stockholder. They also will not be treated as dividends in all cases where the surviving spouse is a substantial, but not a controlling, stockholder.<a href="#_ftn11" name="_ftnref11">11</a> </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. Rev. Rul. 62-102, 1962-2 CB 37. <a href="#_ftnref2" name="_ftn2">2</a>. 363 U.S. 278 (1960). <a href="#_ftnref3" name="_ftn3">3</a>. See Sweeney v. Comm., TC Memo 1987-550. <a href="#_ftnref4" name="_ftn4">4</a>. IRC § 102(c). <a href="#_ftnref5" name="_ftn5">5</a>. IRC § 101(i). <a href="#_ftnref6" name="_ftn6">6</a>. IRC § 404(a)(5); Treas. Reg. § 1.404(a)-12. <a href="#_ftnref7" name="_ftn7">7</a>. Rubber Assoc., Inc. v. Comm., 335 F.2d 75 (6th Cir. 1964); Associated Ark. Newspapers Inc. v. Johnson, 18 AFTR 2d 5894 (E.D. Ark. 1966); Fifth Ave. Coach Lines, Inc. v. Comm., 31 TC 1080 (1959). <a href="#_ftnref8" name="_ftn8">8</a>. Loewy Drug Co. v. Comm., 356 F.2d 928 (4th Cir. 1966); Vesuvius Crucible Co. v. Comm., 356 F.2d 948 (3d Cir. 1965); Montgomery Eng’g Co. v. Comm., 344 F.2d 996 (3d Cir. 1965); Greentree’s Inc. v. U.S. 16 AFTR 2d 5368 (E.D. Va. 1965); Fouke Fur Co. v. Comm., 261 F. Supp. 367 (E.D. Mo. 1966). <a href="#_ftnref9" name="_ftn9">9</a>. Schner-Block Co., Inc. v. Comm., 329 F.2d 875 (2d Cir. 1964); Nickerson Lumber Co. v. U.S., 214 F. Supp. 87 (D. Mass. 1963); Bacon v. Comm., 12 AFTR 2d 6076 (E.D. Ky. 1963). <a href="#_ftnref10" name="_ftn10">10</a>. Jordanos, Inc. v. Comm., 396 F.2d 829 (9th Cir. 1968). <a href="#_ftnref11" name="_ftn11">11</a>. Plastic Binding Corp. v. Comm., TC Memo 1967-147; see also John C. Nordt Co. v. Comm., 46 TC 431 (1966). </div>

March 13, 2024

3639 / Is a contractual death benefit payable to a surviving spouse deductible by an employer?

<div class="Section1">The employer can deduct the death benefit payments provided they represent reasonable additional compensation for the employee’s services ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3519">3519</a>).<a href="#_ftn1" name="_ftnref1">1</a> Payments can be deducted only in the year they are includable in the employee’s income, regardless of the accounting method used by the employer.<a href="#_ftn2" name="_ftnref2">2</a> An employer may not deduct a death benefit paid to (or received by) a surviving spouse to the extent that the employee recognized the value of the arrangement for income tax purposes or purchased the contractual right to the death benefit.<div class="Section1"> Questions as to whether death payments constitute compensation for an employee’s services and, if so, whether the compensation is reasonable typically arise only in connection with payments for stockholder-employees of a close corporation. In several cases it has been held that the payments, even though made under contract, were not compensation but were payments under a plan to provide financial security for the families of the stockholder-employees. Hence, the deductions were disallowed.<a href="#_ftn3" name="_ftnref3">3</a> On the other hand, payments were held reasonable and for a substantial business purpose in M. Buten and Sons, Inc. v. Comm.<a href="#_ftn4" name="_ftnref4">4</a> An employer who prefunds welfare benefit fund benefits will be subject to limits discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4097">4097</a> and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4101">4101</a>. If the funded benefit is considered deferred compensation, the deduction is subject to the rules in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3532">3532</a> or Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3573">3573</a>. </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.   Southern Fruit Distributors v. U.S., 32 AFTR 2d 5598 (M.D. Fla. 1973). <a href="#_ftnref2" name="_ftn2">2</a>.   IRC § 404(a)(5); Rev. Rul. 55-212, 1955-1 CB 299. <a href="#_ftnref3" name="_ftn3">3</a>.   Willmark Serv. Sys., Inc. v. Comm., 368 F.2d 359 (2d Cir. 1966); Wallace v. Comm., TC Memo 1967-11; M.S.D. Inc. v. U.S., 611 F. 2d 373 (6th Cir. 1979). <a href="#_ftnref4" name="_ftn4">4</a>.   TC Memo 1972-44. </div></div>

September 23, 2022

3640.04 / What options do employers have when determining whether to grant a remote employee’s request for FMLA leave?

<div class="Section1">Determining whether to grant FMLA leave can be complicated given the uncertainties generated by remote work arrangements. Employers do, however, have options.</div> <div class="Section1"> To determine whether a remote worker is legally entitled to FLMA leave, the employer will have to conduct a case-by-case analysis to determine whether the employee’s worksite is located for FMLA purposes. The company must examine their physical worksite, reporting site and the site from which assignments come. If the employer does not have at least 50 employees within 75 miles of any of those locations, the employer would have a strong argument that the employee is not entitled to FMLA leave. Other employers may wish to grant FMLA leave to employees who meet the hours-of-service and employment length requirements regardless of their remote location. While this approach can help employers avoid litigation, it can also provide employees with benefits to which they are not legally entitled (depending on the facts). Employers may also be able to assign a reporting worksite and an assignment site to each remote employee when agreeing to continue a remote working arrangement. The employer could then examine the facts to determine whether they have at least 50 employees within 75 miles of those reporting/assigning worksites. </div>

September 23, 2022

3640.01 / What factors should an employer consider when determining whether to permit ongoing remote work arrangements?

<div class="Section1">Editor’s Note: While remote work arrangements are not entirely new, employers should be aware that issues involving remote work are newly in the spotlight for state governments. Because of this, issues involving remote work arrangements are continuing to evolve. Employers who are contemplating a remote work arrangement should be advised of this, and of the need to comply with state-level laws in all states where their employees reside and work—regardless of where the employer is physically located. Failure to comply could subject to the employer to fines, penalties and litigation in the state of the employee’s residence.</div> <div class="Section1"> Many employers and employees have become accustomed to work-from-home arrangements and determined that in-person reporting to a physical office is no longer necessary. However, those employers who continue to permit remote work arrangements should know that most of the temporary relief that was put into place during the pandemic has expired. Now, employers will be required to comply with state-level laws and should consider implementing policies and procedures to ensure that remote work arrangements proceed smoothly. When making decisions to permit remote work arrangements, employers must consider all relevant nondiscrimination laws, including the Age Discrimination in Employment Act, the Americans with Disabilities Act and Title VII of the Civil Rights Act of 1964. Decisions to permit remote work must be made in a nondiscriminatory manner to avoid potential lawsuits under these laws and state-level equivalents. Employers must also consider state-level wage and hour laws. They should consider developing programs to track employees’ work time, ensure that employees are paid for all hours worked (including overtime requirements) and to ensure that employees are provided with any legally required break time during their workday. For many employers, confidentiality and data security are also an issue. These employers should take steps to protect customer information and other confidential information in the employee’s remote work environment (for example, by requiring data protection software). Employers should implement clear policies and procedures that will be followed in determining when to permit remote work arrangements. They should also develop detailed procedures that will govern various aspects of the remote work arrangement. Those policies should address timekeeping requirements, expense reimbursement issues, any in-person reporting requirements, who is responsible for the employee’s work equipment and care, network security requirements and how equipment and documents will be returned to the employer upon termination of the working relationship. </div>

September 23, 2022

3640.05 / Can an employer require a remote worker to sign a noncompete or non-solicitation agreement?

<div class="Section1">Editor’s Note: In April of 2023, the Federal Trade Commission issued a final rule banning nearly all non-compete agreements nationwide. On August 20, 2024, the district court for the Northern District of Texas<a href="#_ftn2" name="_ftnref2">1</a> held that the rule was unconstitutional as it violated the Administrative Procedure Act, and thus issued a nationwide ban on enforcement of the FTC ban. The FTC has appealed a similar decision issued by the Middle District of Florida, but has yet to file an appeal in the Fifth Circuit.</div> <div class="Section1"> Non-compete agreements are often included in employment contracts to prevent employees from accepting employment in the same line of work as the employer or from opening their own competing businesses. Whether these agreements are enforceable varies from state to state. Employers with a remote workforce will be required to consider state and local laws governing the enforceability of noncompetition or non-solicitation and other employment agreements. Those laws have been evolving rapidly in recent years, so that a non-compete agreement that is enforceable in one state may not be enforceable in the state where the remote employee is situated. Employers who permit employees to work remotely from other states will be responsible for monitoring these developing laws. As recently as March of 2022, the California Attorney General issued an alert<a href="#_ftn1" name="_ftnref1">1</a> reminding employers that non-compete agreements are not enforceable in the state of California. Under California law, non-compete agreements are specifically non-enforceable with respect to California residents even if the company operates in another state that does recognize non-compete covenants as enforceable. In New York state, non-compete agreements are only enforceable if (1) the agreement is necessary to protect the employer’s legitimate interests, (2) it does not impose an undue hardship on the employee, (3) the agreement does not harm the public, (4) the agreement is reasonable in time period and geographic scope.<a href="#_ftn2" name="_ftnref2">2</a> Other states have developed new and detailed laws governing the enforceability of non-compete agreements. For example, Colorado<a href="#_ftn3" name="_ftnref3">3</a> has revised its laws on noncompetition and non-solicitation covenants effective August 10, 2022. Under the new law, noncompete agreements are enforceable when they are used to protect trade secrets. However, these covenants must be no broader than reasonably necessary to protect a legitimate interest in protecting the trade secrets in question. Even these non-compete covenants are only enforceable if the employee earns enough income to be classified as a highly-compensated employee when the agreement is entered into and when the company attempts to enforce the agreement (in Colorado, the “highly compensated” limit is $101,250 in 2022, $112,500 in 2023 and $123,750 in 2024, to be indexed to inflation in later years).<a href="#_ftn4" name="_ftnref4">4</a> Non-solicitation covenants are only enforceable against employees earning at least 60% of the highly-compensated employee threshold. Employers will also have to provide the employee with advance notice and give them time to review and agree to the covenant. In Washington D.C., non-competes are enforceable only against employees who earn at least $150,000 per year ($250,000 for medical specialists). While a new law initially banned most non-competes, effective October 1, 2022, the law on non-competes was amended to provide that employers can ban employees from using and disclosing confidential and proprietary information (i.e., trade secrets) during and after the employee’s employment.<a href="#_ftn5" name="_ftnref5">5</a> Employers with a remote workforce will be required to conduct a state-by-state analysis to determine the rules for enforcing non-compete and non-solicitation agreements going forward. </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. Ryan LLC v. Federal Trade Commission, Civil Action No. 3:24-CV-00986-E. <a href="#_ftnref2" name="_ftn2">2</a>. Available at <a href="https://oag.ca.gov/news/press-releases/attorney-general-bonta-reminds-employers-and-workers-noncompete-agreements-are">https://oag.ca.gov/news/press-releases/attorney-general-bonta-reminds-employers-and-workers-noncompete-agreements-are</a> 3. See <a href="https://ag.ny.gov/sites/default/files/non-competes.pdf">https://ag.ny.gov/sites/default/files/non-competes.pdf</a> <a href="#_ftnref3" name="_ftn3">4</a>. Available at <a href="https://leg.colorado.gov/sites/default/files/2022a_1317_signed.pdf">https://leg.colorado.gov/sites/default/files/2022a_1317_signed.pdf</a> <a href="#_ftnref4" name="_ftn4">5</a>. <a href="https://leg.colorado.gov/sites/default/files/2022a_1317_signed.pdf">https://leg.colorado.gov/sites/default/files/2022a_1317_signed.pdf</a> <a href="#_ftnref5" name="_ftn5">6</a>. D.C. Act 24-526. </div>

September 23, 2022

3640.02 / What issues should employers that choose to allow remote work arrangements consider with respect to employer-sponsored health insurance coverage and reporting?

<div class="Section1">Under the Affordable Care Act, employers who have 50 or more full-time employees are required to provide affordable health coverage to employees. That law applies at the federal level to all employers, regardless of where they are situated (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8858">8858</a>- Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8886">8886</a> for more information on the employer mandate).<div class="Section1"> However, many states have also implemented their own ACA-like laws that govern health coverage requirements within the state (i.e., New Jersey, the District of Columbia, Massachusetts, Rhode Island and California have their own health coverage laws in place). Because of that, it is also possible that employers could be subject to penalties for failure to provide affordable coverage at the state level. Those employers will also be subject to state-level reporting requirements if they permit an employee to work remotely from a state that has health coverage laws in effect. Some state laws mirror the federal ACA reporting requirements. However, Massachusetts has developed its own Forms 1099-HC<a href="#_ftn1" name="_ftnref1">1</a> that differ from the federal Forms 1095-C. Employers who permit employees to work remotely from Massachusetts must send Forms 1099-HC to employees within the state. Employers who fail to send the forms can be subject to a penalty of up to $50 per individual (up to a cap of $50,000).<a href="#_ftn2" name="_ftnref2">2</a> The forms must be submitted electronically.<a href="#_ftn3" name="_ftnref3">3</a> The existing state-level reporting requirements for employers are detailed and vary from state to state. Employers who permit employees to work remotely in states other than where the employer is physically located will be required to comply with a variety of state-level laws or risk becoming subject to penalties for noncompliance. </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.   <a href="https://www.mass.gov/service-details/1095-b-and-1099-hc-tax-form">https://www.mass.gov/service-details/1095-b-and-1099-hc-tax-form</a> <a href="#_ftnref2" name="_ftn2">2</a>.   MGL c. 62C, § 8B. <a href="#_ftnref3" name="_ftn3">3</a>.   <a href="https://www.mass.gov/info-details/health-care-frequently-asked-questions-for-employers">https://www.mass.gov/info-details/health-care-frequently-asked-questions-for-employers</a> </div></div>