Care Needed When Paying Disability Premiums

September 17, 2007 | Roger McEowen


Disability insurance should be a part of any worker’s financial and estate plan, but from a tax standpoint, care must be taken as to how the premiums are paid.  If the disability premium is paid from the insured’s personal resources, when the benefits are paid out, they will not be taxable.  The same is true if the employer pays the premiums using after-tax earnings.  If, however, the employer pays the premium on the insured’s behalf and doesn’t use after-tax earnings to make the payments, the benefits will be taxable when the insured receives them.  That’s a key point to remember. 

In a recent case, a lawyer was covered by a group disability policy.  He later suffered headaches so severe that he could no longer practice law.  Things got so bad he had to file for bankruptcy.  But, at least he had some income from his disability policy.  Unfortunately, IRS claimed that his company had paid the premiums without using after-tax earnings, and that the insurance payments were taxable.  The Tax Court disagreed, noting that the lawyer had reimbursed the company for the premiums from his personal funds.  Thus, the disability payments were not taxable.  Cotler v. Comr., T.C. Memo. 2007-283.