There are certain rulings by the IRS that I really love, and one of those recently was probably based on a favorable letter ruling issued to a very creative and resourceful employer.

The unnamed company provides long-term disability benefits under a written plan. In the original terms, it pays the entire premium for the coverage and does not 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.

In Rev. Rul. 2004-55, the IRS said 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. IRS also indicates the same rationale applies to short-term disability benefits.

What is so great about this ruling is that it will encourage amendment of plans to allow for this after-tax option. If someone becomes disabled, there will no tax imposed on the disability benefits that are paid. Without the amendment, employees are forced to purchase individual policies themselves to ensure that the benefits wouldn't be included in income if they became disabled.

This type of ruling won't help most taxpayers but for those affected, it will have a significant impact. I encourage you to advise your clients that provide group disability coverage about this ruling and give IRS and that employer a "Thank You."

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