Income tax season begins soon, and with that comes issuing W2s!
Did you know?
As an employer, if you pay for more than $50,000 in employee basic life insurance coverage, the excess cost should be included in your employees annual income. This often occurs if your company has an employer paid life insurance policy that is a multiple of the employee’s salary; OR if your company pays for a flat dollar amount that exceeds $50k. Be sure to get with your payroll company to let them know you offer this benefit and to ensure they’re filing the employee’s annual income correctly.
Taxability of Disability Benefits
The taxability of disability benefits depends on how premiums for the policy are paid throughout the year. We recommend to read through the 2nd attachment to see which method applies to your company. As a rule of thumb, if premiums are paid pre-tax now, then the benefit will be taxed later on. Or if an employer pays for the disability benefit and does not report the cost of coverage as income for the employee, the employee will pay taxes on the benefit later.
From a benefits standpoint, we recommend that its reported so that the disability income is not taxed when it’s needed. Speak with your accountant or tax advisor to see what makes sense for your company.
Employee Paid Disability: to avoid taxable disability income, do not withdraw premiums pre-tax from the employees paycheck
Employer Paid (or partially paid) Disability: to avoid taxable disability income, report the cost of benefits with the employees earnings.
W2 Reporting, new since 2012
If you will be issuing more than 250 W2s this year, you must include the aggregate cost of employer-sponsored coverage on the W2.
As always, contact us if you have any questions!
Taxability of Disability Benefits—Commonly Asked Questions
Many employers provide employer-paid disability benefits to their employees and/or allow employees to purchase disability benefits. The taxability of these benefits generally depends on how the premiums for the coverage are paid. This Legislative Brief answers common questions regarding the taxability of disability benefits.
Are disability benefits paid to an individual included in gross income?
Benefits paid under a disability policy are included in the recipient’s gross income to the extent that the benefits are attributable to employer contributions.
Are disability benefits paid to an individual included in gross income where the individual has purchased the policy with his or her own funds?
No. Disability benefits are not included in the recipient’s gross income where the individual purchases a policy with his or her own funds. Payments that an employer withholds from an employee’s paycheck on an after-tax basis are considered to be made from an individual’s own funds. Where an employer pays disability premiums from employer funds, it may add the amount of premium paid by the employer to the employee’s gross income in order to provide nontaxable disability benefits to its employees.
Are disability benefits paid to an individual included in gross income where benefits are attributable to contributions made by the employer?
Yes. Disability benefits are included in gross income where benefits are attributable to contributions made by the employer. Payments that an employer withholds from an employee’s check on a pre-tax basis are considered by the IRS to be employer contributions. Where an employer pays disability premiums from employer funds and does not include the cost of coverage in the employee’s gross income, benefits are also considered attributable to contributions made by the employer.
Are disability benefits paid to an individual included in gross income where the cost of benefits is shared between the employee and employer?
Yes. Disability benefits paid to an individual that are attributable to the contributions of the employer are included in gross income. Where employees and the employer both contribute to the cost of the disability policy, the three-year look back rule generally determines what portion of the benefits paid to the employee are included in gross income.
What is the three-year look back rule?
The three-year look back rule is contained in Section 1.105-1(d)(2) of the Code of Federal Regulations. The three-year look back rule explains how taxes owed on disability benefits are determined when a group insurance policy was purchased with employer and employee contributions. Similar rules apply to self-funded disability plans.
For insured plans, the three-year look back rule applies if the employer knows the net premiums for disability coverage for at least the last three policy years at the beginning of the calendar year. To use the three-year look back rule, first determine what percentage of the net premiums is attributable to premiums contributed by the employer. The taxable amount of the benefit is the same percentage of the entire benefit received.
Group-Term Life Insurance: Commonly Asked Questions
Many employers provide employees with employer-paid group-term life insurance benefits or arrange for employees to purchase group term life insurance benefits. This Legislative Brief answers many common questions regarding group-term life insurance benefits. More information on group-term life insurance can be found in IRS Publication 15-B, which is available through www.irs.gov.
Must the cost of employer-provided group-term life insurance be included in an employee’s gross income?
Pursuant to Internal Revenue Code (Code) Section 79, an employee may exclude up to $50,000 of employer-provided group-term life insurance from his or her income. This tax exclusion applies only to insurance on the life of the employee. It does not apply to insurance on the life of the employee’s spouse or dependent or other individual.
In addition, the employer may generally deduct the premiums it pays for the coverage as an ordinary and necessary business expense, so long as the employer is neither directly nor indirectly the beneficiary under the policy.
May the employer provide group-term life insurance for its employees in excess of $50,000?
Yes. However, the “cost” of the coverage in excess of $50,000 must be included in the employee’s gross income. “Cost” as used here does not refer to the premium paid by the employer but to the cost determined under the Uniform Premium Table contained in IRS regulations. The “cost” of the coverage added to an employee’s gross income is commonly referred to as “imputed income.”
Can employees purchase group-term life insurance benefits with pre-tax dollars?
Yes, but only under a Code Section 125 cafeteria plan. Employees may purchase, with pre-tax dollars, up to $50,000 of group-term life insurance without having any “cost” of that coverage included in gross income. An employee may not use this exception if the employer has already provided up to $50,000 of employer-paid group- term life insurance benefits. In this case, amounts paid for the coverage through the cafeteria plan are excluded
