A common characteristic of successful companies is that they seek out and utilize competitive advantages. In today’s market companies face competition not only for
customers but also for employees to service those customers. When it comes to hiring employees you have an advantage over your competition if your benefit package
includes disability insurance. If your disability insurance utilizes the provisions found in Revenue Ruling 2004-55, then you have a competitive advantage.
Before discussing Revenue Ruling 2004-55, it is important to know the following facts about disability insurance:
- Disability insurance benefits usually covers between 50 to 70 percent of an employee’s gross weekly pay. The industry standard is 60 percent.
- If the premium is paid by the employee with after tax dollars (i.e. after withholding taxes are deducted), then any benefit check received by the employee is nontaxable income to the employee.
- If the employer pays the premium, then any benefit received is taxable income to the employee and is subject to federal and state income taxes. It is also subject to FICA taxes – both employee and employer matching.
- As a general rule, individual premiums for disability insurance are higher than group rate premiums.
- Since the employee receives on average 60 percent of this normal paycheck as a benefit payment, if an employee pays his disability insurance premium with after tax dollars, then the resulting benefit received is close to his normal take home pay. (Example: Employee’s normal pay is $1,000. After withholding taxes net pay is $650. Employee incurs a disability and receives disability pay. The benefit check is $600.)
- If the employer pays the disability insurance premium, the benefit is still usually 60 percent of the employee’s gross pay check but the benefit is taxable income to the employee. Taxes are taken out (usually totaling 30 percent) and the net benefit check is substantially less than the employee’s normal take home pay. (Example: Employee normal pay is $1,000. After withholding taxes net pay is $650. Employee incurs a disability and receives disability pay. Since the benefit is taxable, taxes are withheld on the benefit payment. The net benefit check is $450.)
Savvy employers quickly come to the conclusion that that the best outcome occurs when an employee pays for the insurance with after tax dollars. Since group rates are cheaper than individual rates, the premiums should be group premiums. But if you have shopped for disability insurance before, you know that low group rates are only offered by insurance companies if the employer pays 100 percent of the premium, which means the benefits will be taxable to the employee.
Is there a way for the employer to pay the group rate and still have the benefit be nontaxable to the employee? The answer is “YES” if you follow the provisions found in
Revenue Ruling 2004-55. At little or no additional cost, companies utilizing the ruling are able to offer its employees higher paying disability benefits.
Revenue Ruling 2004-55, issued in 2004, states that employers who pay 100 percent of the group disability insurance premium may offer its employees a choice to elect either a tax free or taxable benefit. If the employee chooses tax free, the employee will pay tax on the premiums but not on the benefits received. If they choose taxable, the employee will pay tax on the benefits received but not on the premiums. The election is made once a year and is irrevocable for that year. The election continues from year to year unless revoked by the employee prior to the new benefit plan year. The ruling applies to both short term and long term insurance disability premiums. The election does not have to be the same for both types of coverages.
Why do those companies whose disability insurance plans utilize Revenue Ruling 2004-55 have a competitive advantage? Few companies offer the election to their employees even though it has been out for 10 years. In addition to the higher paying benefits mentioned earlier, companies who use it also find that their overall FICA expense drops since matching taxes on premiums are often less than matching taxes on benefits. Finally these companies gain the trust and respect of their employees when they realize that their company is going the extra mile to get them the best possible benefits available.Contact: Kim Buker (firstname.lastname@example.org) or Jennifer Todd (email@example.com) or (918) 299-2345 Make Your Employee Insurance Disability Plan a Competitive Advantage
Copyright © 2014 by Todd C. Waldeck, CPA. All rights reserved.
This article is distributed with the understanding that the author is not engaged in rendering accounting, tax, insurance or other professional services to the reader but to educate the reader of options available. If expert assistance is required, the services of a competent professional person should be sought.