Current Tax Treatment | GROUP LEGAL EXPENSE INSURANCE

Plans that cover the legal expenses of employees have been a common benefit in several European countries for many years. However, until the mid-1970s, the concept was not widely used in the United States. The plans that did exist were almost always established by unions and were financed from general union funds. Usually, the legal services were provided by attorneys who were employed by the unions, and the only legal services covered were those limited to job-related difficulties, such as suspensions or workers' compensation disputes.

The limited extent of legal expense plans was due to the existence of several obstacles, all of which have been substantially reduced or eliminated in recent years as a result of changes to state and federal laws. In 1973, the Taft-Hartley Act was amended to make legal expense benefits a new subject of collective bargaining, and the Tax Reform Act of 1976 gave favorable tax treatment to certain legal expense plans by providing that neither the premiums paid by employers nor the benefits received under the plans constitute taxable income to employees. As a result of these changes, the number of legal expense plans grew considerably, particularly for union employees as a result of collective bargaining. These plans are typically negotiated trusteeships that provide benefits on an uninsured basis. Some employers have established voluntary plans—possibly as part of a cafeteria plan—under which an employee can elect to participate if he or she desires. In most cases, the employee pays the full cost of the coverage on an after-tax basis. It is also becoming increasingly common for employers to offer some legal expense benefits under employee-assistance plans.

Current Tax Treatment

Under provisions of the 1976 tax act, Section 120 of the Internal Revenue Code was established. This Code section allowed an employer to pay annual premiums to a "prepaid legal services plan" of up to $70 for each employee without the employee's incurring any taxable income. To qualify as a prepaid legal services plan, a group legal expense plan had to meet specific requirements regarding funding and nondiscrimination. Section 120 was always subject to a sunset provision, but the date of expiration was extended several times. However, the section was allowed to expire at the end of 1992. Unless Section 120 is revived at some future date (and periodically there continue to be bills in Congress to do this), any premiums paid by the employer for group legal expenses coverage are treated as taxable income for employees. Benefits are taxable if a plan is self-funded. If Section 120 is revived, favorable tax treatment could also be provided to group legal expense benefits available (within limits) under a cafeteria plan.

The cost of legal expense plans is deductible for the employer. Employees, however, have taxable income to the extent of employer payments. If the plan is prefunded, the employee is taxed on his or her share of the premium paid and benefits are received tax free. If a plan is self-funded by the employer, the employee's taxable income is the value of the benefits paid by the plan.