- Offering disability insurance is an ethically responsible employment decision.
- Improves morale and retention of workers, both of which lead to higher profits.
- Protects you from having to make difficult and legally complicated employment decisions about sick or injured workers.
- Attract recruit better employees when you offer more benefits.
- Multiple options to make disability insurance work. Surprisingly less cost than you may believe.
Let’s say that you have decided to start offering group disability insurance to your employees. That is great news! Next, you need to consider the tax implications of providing such coverage.
What Are Employee Tax Implications?
Disability insurance is used by employees who find themselves unable to work due to illness or injury that is unrelated to their employment. (Employment injuries and illnesses go through worker’s compensation insurance, which is a different topic altogether.)
Before they take advantage of disability insurance, people are going to want to know whether or not the income they draw is taxable. Will they be taxed from the money they take home during their time of short term or long term disability? Or will that income be tax-free?
The answer is not exactly straightforward. Sometimes disability insurance income may be taxable, while other times, it isn’t.
The deciding factors include:
- What kind of benefits you are using (short term disability, long term disability, worker’s compensation, group disability, individual disability, etc.)
- Who paid the premiums (you, your employer, or a combination of the two)
- The pre-tax or after-tax status of the premium payments
When Is Disability Income Tax-free?
Some people choose to pay for their disability insurance through individual policies, using their after-tax income to pay the premiums, then the income is tax-free. Premiums for disability insurance are not deductible from one’s taxes as a medical expense, so it is crucial to keep that in mind when deciding on an individual policy.
What about when disability insurance provided through an employee’s group policy? In that case, the benefits are tax-free, assuming the employee pays 100% of the premium with their after-tax income.
If the employer and employee split the premiums, then the tax benefit is also divided. The employee will pay taxes on the portion of the benefits that correlate to the part of the premium they paid with after-tax dollars.
Finally, if the employer pays the full premium, then the employee will be taxed on the disability income benefits they receive.
Do You Know The Tax Implications for Employers?
What does all of this mean for employers? To start, it means that business owners should be aware of how their decisions about disability insurance can affect their workers. You may also have some questions about what taxes you will be responsible for, regardless of whether or not you have workers who utilize their policies.
Remember these key takeaways:
- If you pay the premiums, your employees will pay taxes on their disability income.
- If your employee pays the premiums with after-tax dollars, the income is tax-free.
- If you split the premiums, you will each pay a portion of the taxes.
- If you provide a mechanism for employees to pay their premiums with pre-tax dollars, their disability income is taxable.
It comes down to whether or not the money used for the premiums was previously taxed, regardless of whether the employer or employee has paid that tax. If the premiums paid with after-tax dollars, the benefits are tax-free – And if paid with pre-tax dollars, the benefit will be taxed.
There are other arrangements, too, that could impact what workers owe. Obtain information from an experienced disability insurance expert. Importantly, your insurance advisor looks at all the different regulations that may impact your decision as well as available payment options.
What Are “key person” Plans?
You may have also heard about another kind of tax-free disability income called Key Person Insurance. In these situations, an employer takes out a disability policy on behalf of one or more irreplaceable employees or executives called “key person.” In an instance when a key person is unable to work for a predefined period, the company suffers significant setbacks and wants compensation for project delays, profit loss, and other issues caused by a person’s absence.
Companies choose to do this when they experience a significant burden if an employee or executive is unable to work due to illness, injury, or disability. It isn’t a particularly common kind of insurance, but it is something that some businesses choose to carry on one or more of their employees.
In this situation, because the employer is paying the premium, and because the premium is not deductible as a medical expense, the employer doesn’t pay taxes on any received benefits.
Are You Providing Good Disability Coverage?
Time to evaluate what you are offering to your workers regarding disability protection. Whether your looking to provide coverage for the very first time or have provided disability insurance coverage for some time, you should learn of what’s available, new or changing. When you are ready to have the qualified agents at Peter Green Insurance Agency (PGIA)look over your current plans and help you find ways to save money and improve employee morale, you’ll be pleased with the results after speaking with us. Call 714-258-2800 or 888-725-7776.
We know of the best group disability plans and tax implications of each disability policy offered!