Life & Health Insurance Exam (National Portion)Taxes, Retirement, and Other Insurance ConceptsEasy
An employer offers a group disability income policy to its employees, for which the employer pays 100% of the premiums. An employee becomes disabled and begins receiving benefits from this policy. How are these disability benefits treated for federal income tax purposes?
- AThe benefits are partially taxable, with only the amount exceeding premiums paid being taxed.
- BThe benefits are fully taxable as ordinary income.
- CThe benefits are subject to capital gains tax.
- DThe benefits are received income tax-free.
Show answer & explanationAnswer & explanation
Correct answer: B. The benefits are fully taxable as ordinary income.
When an employer pays 100% of the premiums for a group disability income policy, the disability benefits received by the employee are considered fully taxable as ordinary income.
Why the other options are wrong
- A. This rule applies to individual disability policies where the employee paid premiums with after-tax dollars, making benefits tax-free up to the amount of premiums paid.
- C. Disability benefits are not treated as capital gains.
- D. This would only be true if the employee paid the premiums with after-tax dollars.
Taxation of Employer-Paid Disability Benefits
If an employer pays all premiums for a group disability income policy, the disability benefits received by the employee are fully taxable as ordinary income.
- Employer premiums are tax-deductible for the employer.
- Employee does not pay tax on the premiums.
- Benefits are fully taxable to the employee when received.
Memory trick: Who pays the 'P'remium determines the 'P'ayment's tax.