How Can a Claimant Exclude Disability Insurance Benefits from Federal Taxes?
As disability lawyers we do not provide any tax advice. We are routinely asked about the tax implications of disability insurance benefits. In an effort to provide some answers in this area we reached out to Gary Kaplan, a certified public accountant.
Issue
What actions can a claimant take in order to exclude Disability Insurance Benefits from personal income tax?
Hypothetical Fact Pattern
A surgeon, Dr. Smith, has been diagnosed with Multiple Sclerosis, which is a chronic disease that becomes increasingly debilitating over time. Dr. Smith anticipates that he will not be able to work in his current profession within 4 years. Dr. Smith has disability insurance through a plan provided by his employer, Surgery Specialists. The medical practice is a separate legal business entity, taxed as an S Corporation, and Dr. Smith is the 100% owner and an employee. Up until now, Surgery Specialists has paid and deducted the entire disability premium as a business expense. Surgery Specialists does not include the cost of coverage as W-2 gross income to Dr. Smith; thus his disability policy is being paid for as a personal tax-free benefit.
Tax Law And Analysis
Under Section 1.105-1(a)of the Internal Revenue Code, if an employee does not include any employer-paid disability insurance premiums in gross income, they will have to pay personal income tax on all future benefits received from the disability policy. Conversely, if the employee pays personal income tax on the entire employer-provided disability premium, none of the disability benefits will be taxable to the recipient.
Under Section 1.105-1(d)(2), provides for what is known as the “three year look back rule”. If the premiums are paid by employer and employee, the individual will only pay income tax on benefits on the ratio of:
Net premiums contributed by the employer for the last three policy years prior to the calendar year in which the disability occurs, divided by the total net premiums paid by both the employer and employee for the same period.
As covered by Revenue Ruling 2004-55, an employer plan can be amended allowing employees to make an irrevocable election to pay for the cost of disability coverage with after-tax dollars (i.e. employee pays income tax on the value of the premiums). The employee’s election is irrevocable for the entire plan year, and can be changed annually before the beginning of each succeeding plan year.
Conclusion
Dr. Smith has the unique situation of knowing his impending disability over three years in advance. He has adequate time to amend his business/employer disability plan, allowing him to make an employee election to pay the disability premiums with personal, after-tax dollars. He would be able to take advantage of the three year look back rule and receive future stream of disability payments tax-free. The long-term tax savings should far outweigh the cost of making after-tax premium payments.
This case study does not consider the tax treatment of Social Security disability payments, or other issues that may affect your particular situation. Tax planning for disability and other complex issues should be made with experienced professionals.
If you have specific questions about tax issues related to disability insurance, Gary Kaplan can be reached at 866-643-3560 or by visiting his website at gkaplancpa.com.
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5 Ways We Help Get Your Benefits Paid
Our goal is to get your application for disability insurance benefits approved. Applying for disability insurance benefits can be a difficult process and the information you provide is critical. Most disability insurance companies look at your application in hopes of finding a reason to deny your claim. Your disability company will ask you to complete numerous forms, interview you, request lots of information, speak with your doctors and possibly request to have you examined by their hired gun doctor.
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We are disability insurance attorneys that know how to get your short or long term disability benefits paid. As a nationwide law firm we have helped thousands of disability insurance claimants throughout the United States to collect hundreds of millions of dollars of disability insurance benefits from every major disability insurance company.
Our attorneys have been able to either get our clients paid monthly disability benefits or obtain a one-time lump-sum settlement in more than 98% of our cases. Our disability insurance lawyers have seen it all when it comes to disability insurance claims and we know exactly what it takes for your disability claim to be approved.
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Our disability insurance attorneys help individuals that have either purchased a long term disability insurance policy from an insurance company or obtained short or long term disability insurance coverage as a benefit from their employer. We have helped individuals in almost every type of occupation with monthly disability benefit payments ranging from $1,500 to $50,000.
Our clients include all types of employees ranging from retail associates, sales representatives, government employees, police officers, teachers, janitors, nurses, pilots, truck drivers, financial advisors, doctors, dentists, veterinarians, lawyers, consultants, IT professionals, engineers, professional athletes, business owners, and high level executives.
A strong understanding and presentation of the duties of your occupation is essential for securing disability insurance benefits.
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Since we represent disability insurance claimants at different stages of a disability insurance claim we offer a variety of different fee options. We understand that claimants living on disability insurance benefits have a limited source of income; therefore we always try to work with the claimant to make our attorney fees as affordable as possible.
The three available fee options are a contingency fee agreement (no attorney fee or cost unless we make a recovery), hourly fee or fixed flat rate.
In every case we provide each client with a written fee agreement detailing the terms and conditions. We always offer a free initial phone consultation and we appreciate the opportunity to work with you in obtaining payment of your disability insurance benefits.
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