The Wage Loss and Tax Benefits of Disability Insurance

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Disability insurance is a common method to provide individuals with income during an illness or as they recover from an accident.

Many companies find it a wise investment to cover key executives and critical employees with individual disability policies. Not only does this protect companies and employees, but also provides tax benefits to both. Companies can also receive premium discounts when several individual policies are purchased as a group from an insurance carrier.

In what is often known as a “wage loss replacement plan,” the company pays the premiums and the disabled employees receive payments directly. Some plans will transfer the policy to employees when they are terminated or retire.

From the tax perspective, there are two scenarios to consider.

As with most employee insurance (health, dental, etc.), the premiums that the employer pays are tax deductible by the company. Employees do not receive a tax benefit and the disability payments that go to employees are taxable income (minus any employee contributions).

A company could also elect to make the premium amount of the policy part of an employee’s compensation package. An employee would have to be pay taxes on that amount. To eliminate employees being taxed on the disability payments, when sick or injured, the employer could first add the amount of the premium to an employee’s salary. The employer deducts the premium payment, and then withholds and remits income tax deductions based on the higher salary.

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