Taxing Disability Premiums

System

Following an audit of our benefit plan, our insurance broker recommended a change regarding our STD benefit.

Presently, our company pays 100% of the premium for STD coverage, which amounts to 60% of an employee's weekly base pay capped at $5k./month. When someone is out on disability, that 60% is currently subject to applicable state and federal taxes.

The suggestion is to begin taxing the premium for all employees, whether they use the benefit or not. The taxable benefit would be added as other income on the employees W-2's and would not amount to significant dollars. (i.e. An EE earning $50k would see about an additional $160).

The result, employees on disability would receive the full 60% benefit.

Anyone heard of this or actually handling the STD this way?

LindaS

[font size="1" color="#FF0000"]LAST EDITED ON 08-27-03 AT 02:54PM (CST)[/font][p]Several years ago I was advised by our auditors that if the premiums are paid pre-tax by the employee then the benefit they receive as a result of this premium are taxable. If they pay taxes on the premium, the benefit they receive then is NOT taxable.

To answer your question, we began employing this practice.

WT

There are some assumptions here that should be looked at. It is my understanding that if an employee PAYS FOR disability coverage then such coverage need not be taxed (except for social security). If a proportion of the coverage is paid for by the employee, taxes would be proportional. If we speak of taxing this benefit, I assume it is meant that the total premium would be added to the employee's W-2 form, essentially raising their wage by that amount. In that case, they would be paying for the disability.

NaeNae55

One final note. When determining if this kind of benefit is taxable, the IRS will often look to see how long the employee paid taxes on the premiums. So if you change now and an employee doesn't need this benefit for years, then the benefit will not be taxed. But if you have someone who needs this in the near future, the IRS will look at how long the employee did not pay taxes on the premium and the employee will be taxed. Just make sure your employees understand there is a window of time that the taxes may be allocated based upon past history.

System

NaeNae55 - that's how I thought this should work. But we implemented a similar scenario eff 1/1/03 for LTD. It's an employer-paid benefit, but we give employees the option to pay the premium and the taxes on the premium and then reimburse them the premium (net of taxes) on the same paycheck. Therefore, when they receive an LTD benefit, it will not be subject to taxes. This plan was "given" to us by our owner/parent company who has been offering this premium payment option for several years.

I specifically asked about a situation we have coming up with an employee who is currently out on STD. He wants to elect this premium payment option at upcoming fall open enrollment, to be eff 1/1/04. His LTD would begin (if still disabled) in early February, so he would only be paying the taxes on the premium for approx one month. In this scenario, I was told that he would receive a "tax-free" benefit, regardless when he started paying the tax. That there were no time requirements.

It seemed odd to me, because I worked with a plan that had a buy-up option with employee contributions and when we had someone apply for LTD, the carrier required us to tell them specifically when the employee paid and for how long and what portion of premium did they pay it. But in this case, our vendor's contract is administered by our owner company, so I'm assuming they have this covered in the right way.

System

Thank you for your responses and input. It will help us reach a decision on this issue.