ABC Taxes, Tips & Tools

Many employ­ers offer employee dis­abil­ity insur­ance to their employ­ees.  How these pay­ments play out in terms of income and deduc­tions are defined by spe­cific circumstances:

• Who pays for the insurance
• Who is the ben­e­fi­ciary of the insurance
• Whether the pre­mi­ums are taken pre-tax or not, and
• What oblig­a­tion the employer has to con­tinue their employee’s pay under disability
• If the insur­ance is gov­ern­ment dis­abil­ity insur­ance or not

 Deductibil­ity of dis­abil­ity insur­ance pre­mi­ums.

• Unlike health insur­ance, dis­abil­ity insur­ance is not deductible as a med­ical expense to the individual. 
• How­ever some­times employ­ers pay for the dis­abil­ity insur­ance of key employ­ees nam­ing the com­pany as a ben­e­fi­ciary and in this case the com­pany may be able to deduct the premium. 
• Some­times an employer spon­sors a group dis­abil­ity plan in which case the employer may be able to deduct pay­ments that they make as an employee benefit. 

 Is the pay­out of a dis­abil­ity pol­icy tax-free?

• In gen­eral insur­ance pay­outs whose pre­mi­ums have been paid for with after-tax income are not tax­able income. 
• How­ever, if the ben­e­fi­ciary of a dis­abil­ity pol­icy is an employee who has not paid for the pol­icy or only paid for part of the pol­icy the pay­out itself also may be com­pletely or par­tially tax­able to the employee. 
• If the employee’s dis­abil­ity pol­icy is part of cafe­te­ria plan paid for with pre-tax dol­lars then the pay­out will be taxable. 

 e.g. Fred’s employer spon­sors a dis­abil­ity insur­ance plan; Fred pays 100% of the pre­mi­ums through pay­roll deduc­tion with after-tax dol­lars.  If e.g.  Fred becomes dis­abled and receives a pay­out from this dis­abil­ity pol­icy; none of the pay­out is taxable.

 e.g. Fred’s employer spon­sors a dis­abil­ity insur­ance plan; Fred’s employer each chip in 50% of Fred’s dis­abil­ity pol­icy. Fred pays his por­tion with after-tax dol­lars through a pay­roll deduc­tion.  Fred becomes dis­abled and starts receiv­ing pay­ments from this dis­abil­ity insur­ance pol­icy; ½ of the pay­ments will be tax­able income. 

e.g.  Fred has a dis­abil­ity pol­icy par­tially paid for by his employer and par­tially paid for by pay­roll deduc­tion as part of a cafe­te­ria plan that is taken out of his pay­check pre-tax.  In this sce­nario all dis­abil­ity pay­outs received by Fred are taxable. 

e.g. The com­pany is the ben­e­fi­ciary of the dis­abil­ity pol­icy for Fred, a key employee. The com­pany has no oblig­a­tion to pay Fred pro­ceeds from this pol­icy. The dis­abil­ity pay­ment made to the com­pany is excluded from the company’s income. 

The com­pany has guar­an­teed Fred’s salary regard­less of his abil­ity to work or phys­i­cal con­di­tion AND the com­pany has a pol­icy to insure it against injuries to employ­ees AND the com­pany, not the employ­ees, is the ben­e­fi­ciary AND the com­pany has no oblig­a­tion to pay employ­ees from the pro­ceeds of this pol­icy. The guar­an­teed salary paid to Fred while he is dis­abled is still deductible to the company. 

Gov­ern­ment dis­abil­ity insurance

How much of the ben­e­fit form a gov­ern­ment dis­abil­ity pay­out is tax­able depends on the type of gov­ern­ment dis­abil­ity ben­e­fit the ben­e­fi­ciary receives.

• Social Secu­rity ben­e­fits: Part of Social Secu­rity is tax­able if the recipient’s mod­i­fied adjusted gross income plus one-half of their Social Secu­rity ben­e­fit exceeds the base amount for their fil­ing sta­tus. In 2009 the base amounts were $32,000 for Mar­ried fil­ing Joint, $0 for Mar­ried fil­ing sep­a­rate and $25,000 for Sin­gle, Head of House­hold or Qual­i­fy­ing Widow(er).  The tax­able por­tion of Social Secu­rity ben­e­fits can­not exceed 85% of those benefits. 
• Medicare ben­e­fits: When a per­son is dis­abled, they may be eli­gi­ble to enroll in Medicare.  If they pay pre­mi­ums for the med­ical insur­ance por­tion of Medicare, they may be able to deduct these pre­mi­ums as a med­ical expense.  In addi­tion, Medicare ben­e­fits they receive are not taxable.
• Work­ers’ com­pen­sa­tion: Gen­er­ally, work­ers com­pen­sa­tion is not tax­able.  Any ben­e­fits paid to the worker’s sur­vivors would also be tax exempt.  How­ever, in cer­tain cases, the worker may be able to return to work and con­tinue to receive pay­ments.  If this is the case, then their work­ers’ com­pen­sa­tion ben­e­fit would be tax­able.  How­ever, if part of the work­ers’ com­pen­sa­tion ben­e­fit reduces their Social Secu­rity ben­e­fit, then that part is con­sid­ered to be a Social Secu­rity ben­e­fit and may be tax­able accord­ing to the rules gov­ern­ing Social Security.
• Vet­er­ans ben­e­fits: Dis­abil­ity ben­e­fits received from the Depart­ment of Vet­er­ans Affairs, for­merly known as the Vet­er­ans Admin­is­tra­tion, are not tax­able, except for cer­tain pay­ments for reha­bil­i­ta­tive services.
• Mil­i­tary ben­e­fits: Most mil­i­tary dis­abil­ity pen­sions are tax­able.  How­ever, if the sol­dier was dis­abled due to injury or ill­ness result­ing from active ser­vice in the armed forces of any coun­try, their dis­abil­ity ben­e­fits may be tax free under cer­tain conditions.
• Fed­eral employ­ees retire­ment sys­tem (FERS) ben­e­fits: If a fed­eral employee retires on dis­abil­ity, the pay­ments under FERS they receive from a pen­sion or annu­ity are tax­able as wages until they reach min­i­mum retire­ment age.  Begin­ning on the day after they reach min­i­mum retire­ment age, pay­ments they receive are tax­able as a pension.

 As always, small busi­ness ser­vices and tax­a­tion are our busi­ness.  If you have any ques­tions about the tax­a­bil­ity of dis­abil­ity pay­outs, the deductibil­ity of insur­ance or if you need help Please give Art & Busi­ness Con­sult­ing a call.  We would love to engage you as a client.

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Tags: deductibility, disability, goverment disability, insurance, payout, taxability

This entry was posted on Thursday, January 28th, 2010 at 3:21 pm and is filed under Business Taxes, Individual Taxes, Other Information. You can follow any responses to this entry through the RSS 2.0 feed. Responses are currently closed, but you can trackback from your own site.