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Life happens. So, it’s not uncommon that an employee may have to step away from work responsibilities for a short term or long term due to injury, accident on the job, illness and more.
Businesses who have provided disability insurance as a benefit option to employees have income tax reporting obligations regarding those benefits.
This issue is one that can lead to mistakes about taxation on disability premiums and benefits. Who pays the premium for disability coverage and whether it is paid with pre-tax or post-tax dollars are key factors in determining the taxability of disability benefit payments.
Disability Premium Payments: Generally, when long-term or short-term disability benefits are provided through a non-elective group insurance policy through a third party carrier, the employer pays for the premium with pre-tax dollars and that premium payment is not reportable as income to the employee.
An eligible employee may choose to have the employer pay for the long-term disability on an after-tax basis electing to be taxed currently on the premiums paid by the employer. In that case, the employer would allocate the appropriate proportion of the group premium to that employee and it would be included as a taxable addition to the employee’s gross annual income on that employee’s W-2.
Disability Payments: If an employee has purchased his or her own disability insurance policy entirely out of his or her own pocket with post-tax dollars, amounts received as disability payments following a qualifying event, such as personal injury or sickness, are not taxable and do not have to be reported as income. This is the only scenario when all of the disability benefits are tax free.
If an employee and the employer have both paid a portion of disability insurance premiums, then the percentage of the premium that was paid by the employer is applied to the total benefits paid and that percent of the benefits is considered to be taxable.
Benefits received are also 100% taxable if an employer pays a portion of the of the premium and an employee pays the balance with pre-tax dollars or the employee pays 100% of the premium with pre-tax dollars.
Insurers must provide employers with a report of the amount of disability payments made to employees. Employers must then provide employees with accurate Forms W-2 detailing disability payments they received even if the employee no longer works for the business.
As with other income, the taxable disability payments are also subject to federal and state withholding. An employee can request that their insurance provider withhold the necessary taxes from taxable disability payments or the employee can make estimated tax payments to avoid penalties.
An exception is made for disability payments compensating for injuries incurred as a direct result of a terrorist attack against the United States. These payments are not taxed as income in most cases. This tax provision provides relief to victims of the September 11, 2001 attacks, the 1995 Oklahoma City bombing and the 2001 anthrax terrorist act.
For more information on disability benefits and taxation issues related to them, contact McRuer CPAs online or call us at 816.741.7882 or check out IRS information online to determine how this issue may affect you, your business and/or your employees.
