Washington (June 21, 2004) -- Employers that provide disability benefits coverage for employees can leave the taxability of the benefits up to the employee, according to a recent ruling by the Internal Revenue Service.
The ruling is important for businesses that have traditionally paid long-term disability insurance premiums for their employees, notes CPA Michael I. Stein, tax partner at Legacy Professionals LLP, in Chicago. "The ruling allows these employers to amend their existing plan to permit employees to irrevocably elect to have the long-term disability premiums included as taxable income on their W-2. If an employee makes this election, long-term disability benefits received under the plan will not be included in the employee's income for tax purposes," said Stein.
Stein added, "The key factor in making this ruling favorable to businesses is the IRS position that the amended plan is a new plan, and that the payment of premiums by the employer in prior years under the original plan will not taint the nontaxable nature of benefits received under the amended plan."
Under the facts in the ruling, Rev. Rul. 2004-55, an employer provides long-term disability benefits under a written plan. Under the original terms, the employer pays the entire premium for the coverage and doesn't include that cost in the employee's gross income. The plan has been amended so an employee may also irrevocably elect to have the employer pay for the coverage on an after-tax basis. The election is irrevocable once the plan year begins and must be made prior to the plan year in which it becomes effective. The employee can make a new election each year.
In lieu of a new election, the employer may provide that an employee's prior election, once made, continues from one year to the next unless affirmatively changed before the beginning of the new plan year. The employer may also provide that the premiums will automatically be included in the employee's gross income for the year unless the employee affirmatively elects otherwise prior to the beginning of the new plan year.
The IRS ruled that benefits received by an employee who irrevocably elected coverage on an after-tax basis for the plan year that the employee becomes disabled are attributable solely to after-tax employee contributions excludable from the employee's gross income. Benefits received by an employee whose coverage is paid on a pre-tax basis for the plan year in which the employee becomes disabled are attributable solely to pre-tax employer contributions and are includable in his or her gross income. The IRS also indicated that the same rationale applies to short-term disability benefits.
-- Howard M. Wolosky
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