Disability and Life Insurance – A Practice Perspective on These Employee Benefits

With year end behind most medical practices, now is the perfect time to look at employee benefit plans and determine if the practice and its owners are getting the best results from their offered benefits. Some employee benefits can be structured to allow for disparity in favor of the physicians in a practice.

Life Insurance

For example, as an employer, you can choose to include all of your employees in a group
term-life insurance plan, or select only a class of employees, such as physicians. You can also exclude certain employees from coverage. For instance, you could require employees to work a minimum number of hours per week, such as 20, before they would qualify for coverage. You could also exclude employees based on the number of months worked per year, such as requiring at least five months of work in order to obtain coverage. Or, employees may have to have been employed for a certain period of time before they are eligible to participate.

Additionally, you can offer different coverage amounts for different classes of employees. For example, you might buy $50,000 of coverage for your administrative personnel, but buy coverage for your physicians equal to three times their annual salaries. It is extremely important that your classes of employees are not determined by reference to their stock ownership.

Employers often stop at $50,000 of coverage for tax reasons. The cost to provide coverage of up to the $50,000 limit is deductible by the employer but not includable in the income of the employee. Also, an employee’s beneficiary will not pay federal income taxes on the death benefits.

Employers that pay for more than $50,000 of group term coverage must include the ‘economic value’ of the cost of the excess insurance as taxable income to the employee (reported on their W-2s as ‘additional compensation’). One way around these limitations is for an employer to pay for the first $50,000 of coverage and allow employees to pay for any optional coverage in excess of this amount.

Some group term policies may offer supplemental coverage (for a spouse) or dependent coverage (for children). These coverage amounts often carry limitations. For instance, the spousal coverage may be limited to 50{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} of the employee’s amount, while dependent coverage may be a flat amount, such as $2,000. The full value of these premiums must be included in the employees’ wages if paid by the employer.

As mentioned, you may pay all or part of the cost of group life coverage, and many employers pass on the costs of any additional features to their employees. The good news, from a federal income-tax standpoint, is that group term-life premiums paid by an employer are tax-deductible by the business, even if your plan is discriminatory.

Also note that the way your business is organized will affect your business tax benefits. Owners of more than 2{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} of an S corporation, partners, and sole proprietors are not considered employees, so premiums paid for their group term insurance are generally not tax deductible. In a corporation that is not an S corporation, premiums paid for all employees (including owner-employees) are generally tax-deductible.

Disability Insurance

If an employee collects benefits on a disability-insurance policy, the taxability is dependent on how the insurance premiums were paid.

Some practices have the policy of self-insurance, at least for short-term disability. If the income is paid directly by the employer, it is taxable to the recipient just as their ordinary salary would be. (Taxable benefits are also subject to federal income-tax withholding, although, depending on the employer’s disability plan, in some cases they are not subject to the Social Security, or FICA, tax.

Frequently, the payments are not made by the employer but by an insurance company under a policy providing disability coverage or under an arrangement having the effect of accident or health insurance. If this is the case, the tax treatment depends on who paid for the insurance coverage. If you the employer paid for it, then the income is taxed to the employee just as if paid directly by the employer. On the other hand, if it’s a policy the employee paid for, the payments received are not taxable.

Even if you (the employer) arrange for the coverage, i.e., it’s a policy made available to employees at work, the benefits are not taxed to the employee if he or she (and not you the employer) pays the premiums. For these purposes, if the premiums are paid by you (the employer), but the amount paid is included as part of the employee’s taxable income, the premiums will be treated as paid by the employee. The tax treatment of the benefits received depends on the tax treatment of the premiums paid.

Example 1: Max’s salary is $1,000 a week ($52,000 for the year). Additionally, under a disability insurance arrangement made available to him by his employer, $10 a week ($520 for the year) is paid on his behalf by his employer to the insurance company. Max includes $52,520 in income as his wages for the year: the $52,000 actually paid to him plus the $520 in disability insurance premiums. Under these facts, the insurance is treated as paid for by Max. If he becomes disabled and receives benefits under the policy, the benefits are not taxable income to him.

Example 2: The facts are the same as in example 1, except that Max includes only $52,000 in income as his wages for the year because the amount paid for the insurance coverage qualifies as excludable under the rules for employer-provided health and accident plans. Under these facts, the insurance is treated as paid for by the employer. If Max becomes disabled and receives benefits under the policy, the benefits are taxable income to him.

In deciding how much disability coverage is needed to protect an employee, you should take the tax treatment into consideration. If the employee is paying or including the premiums paid on his or her behalf in income, they only have to replace their after-tax (takehome) income because their benefits will not be taxed. On the other hand, if you (the employer) are paying for the benefit, keep in mind that they will lose a percentage of it to taxes. Typically group disability is structured to replace 60{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} of earnings. This is because it is assumed that the policy will be structured to provide tax-free benefits.

If the income-inclusion option outline in example 1 above is chosen, inclusion of the premium on a weekly or at least monthly basis is advisable. This eliminates any tax issues when employees terminate and the employee’s portion of Social Security taxes cannot be recovered when the amount is added to the W-2 at year end. It is also advisable since it documents the after-tax treatment of the premiums should the employee become disabled during the year. The IRS has challenged the aftertax treatment when amounts have not been consistently added to income on a year-over-year basis.

So, given that it is advisable to include the disability premium in taxable income, there is no rule requiring the benefit to be offered on a non-discriminatory method. The insurance carrier may have requirements to purchase a group product. You should consult with your accountant or business advisor to do a cost-benefit calculation to determine if the lower premium of a group policy outweighs the additional cost of covering all employees. This can be especially true with short-term disability policies.