Discussion:S Corp - Deduct Disability Insurance

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Discussion Forum Index --> Tax Questions --> S Corp - Deduct Disability Insurance


Kenneth135 (talk|edits) said:

6 March 2007
My client is an S corp and pays disability insurance out of the S corp for all the employees.

I back out the shareholder premium and do not deduct it since there is no deduction for fringe benefits for a more than 2% shareholder. But can the S corp deduct disability insurance paid for employees?

Riley2 (talk|edits) said:

6 March 2007
The premiums are deductible for the shareholder(on the officer salary line), but the officer must include the amount on his W-2. The premiums for non-shareholders would be deductible on the fringe benefit line as tax-free benefit.

Kenneth135 (talk|edits) said:

6 March 2007
I never heard of including disability payments in the W-2. Can you reference anything in writing? What if it is not included in the W-2? So are you saying that the corp can deduct the employee portion of the disability insurance but when the employees receives the disability then it is tax free. You can have it both ways. I think it is non deductible and tax free when they receive it.

Riley2 (talk|edits) said:

7 March 2007
It is deductible on the officer compensation line of the return. Since the amount of the premium is included in the employee's gross income, the disability benefits would be 100% tax-free. See Sec. 105(a) and 104(a)(3).

Kenneth135 (talk|edits) said:

7 March 2007
So what about the employees premiums. Deductible and how do they treat the money if they collect?

Kevinh5 (talk|edits) said:

7 March 2007
If the employer pays for the disability insurance premium, then when the employee collects benefits it would be taxable income to him. Better for each employee to pay with after tax money - then any claim would be tax free.

People do the stupidest things trying to save 10 cents when it will cost them thousands of dollars later.

Blrgcpa (talk|edits) said:

7 March 2007
It depends. In NY the max deduction for dlb on the p/r is $.60/week. It is up to the employer to deduct it or not. If the employee contributes to the payment, then that part of the receipt is tax free. If the employee does not contribute, then it's fully taxable when collected.

Blrgcpa (talk|edits) said:

7 March 2007
It's an insurance expense.

Kevinh5 (talk|edits) said:

7 March 2007
saving pennies to cost someone big dollars later

Kenneth135 (talk|edits) said:

7 March 2007
So if the employer deducts disablity as an expense,You say it is up to the employer, then does the employer tell the employees that if they become disabled, they have to report that as income. Is this in a memo form, how do they tell the employees whether they deducted it or not.

Kevinh5 (talk|edits) said:

7 March 2007
The employees would see the deduction on their pay stub as an after-tax deduction because they would be paying the premium.

For this reason the premium modal payment should be set up monthly - otherwise you may have to deduct $1,600 all at once from someone's check this week to cover the $1,600 bill paid.

Think about it- $1,600 paid by corp week 1. Employee deduction week 1 only 30.77 (1/52 of the amount). Disability comes week 2. Company paid $1,600 - 30.77 = 1,569.23 or 98.076875% of the premium. Therefore 98.076875% of the benefits would be taxable. - Totally defeating the purpose.

Oh I suppose you could set up a N/R employee and sign a note and charge interest, but clients never really do that, do they?

JR1 (talk|edits) said:

March 7, 2007
Just to note my agreement, never ever have the disability deducted if you can help it. When/if you draw it, and the odds are about 4-1 that you'll need disability rather than life insurance during worklife...you don't need taxes on the meager income that you'll get on top of all the other troubles during that time.

Riley2 (talk|edits) said:

8 March 2007
The fact that the employer deducted or did not deduct the premiums does not really determine taxability of the disability benefits. The real determinant is whether the employee excluded the cost of the premiums from gross income. In the case of a more than 2% shareholder, he would not be able to exclude the premiums from gross income.

Kenneth135 (talk|edits) said:

10 March 2007
I have a S corp who pays all the disablity insurance for all employees and does make them pay for any of it. I just dont deduct it on the corporation tax return.

Riley2 (talk|edits) said:

10 March 2007
Don't know of any reason to avoid deducting this. This is fully deductible under Reg ยง 1.162-10(a) as long as the expenses are ordinary and necessary.


Tbm103 (talk|edits) said:

6 April 2009
Are disability insurance premiums deductible to the taxpayer on a schedule C?

Blrgcpa (talk|edits) said:

6 April 2009
Yes.

Riley2 (talk|edits) said:

6 April 2009
The cost of DI premiums for the proprietor are nondeductible unless it is an overhead protection policy.

Wwtaxes (talk|edits) said:

6 April 2009
But if deducted, payments are taxable, so make sure that's what you really want to do.

Riley2 (talk|edits) said:

7 April 2009
Overhead replacement policy proceeds are always taxable -- even if the insured did not deduct the premiums.

Moon101 (talk|edits) said:

23 March 2011
If a more than 2% shareholder records disability insurance for themselves as an expense on the S-Corp books, then they have to report the premiums as wages on the W2 (not subject to SS/Med). Then, on their personal return they can take a deduction for it as a self employed insurance on the face of the 1040? It would be a deduction on the corp books and a wash on the individual.

I know this is true for health insurance, but what about disability insurance?

Death&Taxes (talk|edits) said:

23 March 2011
Turn the question around. Would you deduct disability insurance as SEHI? Of course not, so it doesn't work here, but what you have done is give your client basis so that if he does collect, it should be tax free since he paid for it with after tax dollars.

Landertax (talk|edits) said:

20 October 2011
I have a S corporation shareholder who is disabled in 2011. So now the questions is whether the disability payments are taxable.

There is the owner of the policy and the beneficiary. Above it is assumed the owner of the policy is the corporation. To take an extreme example what if my Aunt Nellie has a personal disability policy and she has nothing to do with the corporation and the corporation pays the premium. It does not matter that the corporation paid the premium because the corporation was not the owner or beneficiary of the policy. Now let's say the S corporate shareholder takes out a policy in his own name, and he is also the beneficiary. He pays for the premiums thru the S corp.

Isn't there a critical question of who owns the policy? Isn't the first question before you even get to the question of who is paying for the policy and thus taxable or not taxable?

The other thing I am reading about is that the issue of taxable or not taxable is determined each year as to whether the premiums are included in that years W-2. There is an duty on the S corporate shareholder to elect to have the premium included in his W-2 to avoid tax on the benefit, otherwise it is taxable. I am not sure whether simply offseting the premium to the due from account is the same thing as including the payment in the W-2. So even though my S corp shareholder did not make that election in 2010, he could make that election in 2011 (we have taken no salary in 2011 yet) the year he had the stroke and include the premium in his W-2 for 2011 and thus the disability payments for the rest of his life are non taxable? Seems amazing. It is this the result then I would always deduct the premium and not included in the W-2, except for the year of disability. I was reading that there may be an allocation between who paid what over the last 3 years, but even that result is generous, because I could go back and amend 2010 and 2009. Or 2011 is included in the W-2 and 2010 and 2009 and earlier years are not included in the W-2 and then at least 1/3 of the benefit is non taxable. There is a 2004 reg. if you have the cite that would be a great help.

My third and final question is my shareholder is in his 70s. I am thinking that the policy for disability might convert to a retirement policy at the age of "normal retirement". Maybe he has already crossed the age of normal retirement and thus it is no longer a disability benefit, but a retirement benefit. This issues would be controlled by the insurance contract.

If you could help me with the thinking on the first two issues it would be much appreciated!!

Art

Ckenefick (talk|edits) said:

20 October 2011
So even though my S corp shareholder did not make that election in 2010, he could make that election in 2011 (we have taken no salary in 2011 yet) the year he had the stroke and include the premium in his W-2 for 2011 and thus the disability payments for the rest of his life are non taxable? Seems amazing.

A couple of points: This election you're talking about is irrelvant for a 2% S-corp shareholder. Disability insurance paid by an S-corp on behalf of a 2% shareholder is not a tax-free fringe benefit. It's similar to 2% S-corp health insurance, taxable on the W2 of the shareholder, except FICA applies.

Second, see RR 2004-55, which is based on a slew of PLR's from 2001. You will note that for rank-and-file employees (or say, a shareholder of a C-corp), the election is irrevocable and must be made before the beginning of the tax year. Keep in mind this is a RR, which carries a lot of weight. But also keep in mind, it only expresses the IRS' legal opinion of the facts presented, one of which is that an irrevocable election be made prior to the beginning of the tax/plan year. So the question arises: Would a favorable ruling be issued if the Plan allowed an election to take place at any point during the year, including after the employee became disabled? I seriously doubt it.

The history here is that employees (including C-corp shareholders) would not after-tax their employer-paid DI premiums...or at least not immediately. They'd wait, wait and wait some more. If they didn't become disabled by year-end, they'd let the expense run through the corp with no W2 inclusion. If they did become disabled, then they'd pick-up the DI premiums as taxable on their W2. So, in effect, they would use hindsight to make the decision, which of course, the IRS didn't like to much.

Landertax (talk|edits) said:

21 October 2011
Thank you Mr. ChKenefick,
    After reading some more, it appears there is no election for a greater than 2%  employee-shareholder.  As you said there is no tax free benefit allowed for a greater than 2% shareholder.  The greater than 2% employee-shareholder MUST pick up the premium payments on his W-2.  And thus the disablity payment is tax free because the 2% employee-shareholder paid for it with his own tax dollars.
    It does appear that I am REQUIRED to report the premium as wages and that my client who had a stroke in 2011 will not be taxed on the disability benefits.
     I would credit disability insurance expense and debt the salary expenses for the the 2% employee-shareholder.
     Incredible result!!!

Kevinh5 (talk|edits) said:

21 October 2011
Do you also have an obligation to amend prior year's W-2s?

Ckenefick (talk|edits) said:

21 October 2011
Maybe, maybe not. If I have a guy that doesn't put it on his W2, I show it on the 1040 as S/E income.

Landertax (talk|edits) said:

22 October 2011
Hi Folks,
  I really am so thankful for Tax Almanac.  For a person like myself who is on his own,  it is like having a hallway full of partners to go talk to.
  My thinking is even if the corporation failed to included it in 2010 W-2 for the 2% employee-shareholder of the S corp, that does not change the underlying conclusion that the benefit is tax free.  In other words if the IRS can in an audited they would not say the disability benefit of 70,000 a year is taxable because the premium was not included in the W-2.  The IRS would say you have to amend the W-2.
  This is a brand new client for me and I did not prepare the W-2s for 2010.  The premiums were not reported on a W-2 in the past. So I guess I need to advise my client to amend the W-2s.  And to go back three years and amend the 1040s.  I guess this is my ethical duty.

So this is great. I had orginally read the general rule that if the corp pays the premium, then it is taxable to the employees. But his is a major exception for S Corps to the general rule.

Have a wonderful week and get out and take a big breath of Fall air!!

Doug M (talk|edits) said:

22 October 2011
I am not so sure about the statement above So I guess I need to advise my client to amend the W-2s. And to go back three years and amend the 1040s. I guess this is my ethical duty

There is the notion in the law that you pro-rate. That being, if a person was in a situation where half the premiums were deducted pre-tax, and half the premiums were paid with post tax dollars, then 50% of the disability payments are taxable.

Ckenefick (talk|edits) said:

22 October 2011
That being, if a person was in a situation where half the premiums were deducted pre-tax, and half the premiums were paid with post tax dollars, then 50% of the disability payments are taxable.

This can get very confusing. Isn't the current thinking that the premiums paid under the current policy (i.e. the policy that is paying the benefits) is subject to this rule? In other words, if a policy runs 1/1/11 through 12/31/11 and I pay a 6-month premium up front, on 1/1/11, why would it matter if the premiums were reflected in my taxable income prior to 1/1/11? In other words, the benefit I receive in 2011 due to my disability on 5/31/11 is NOT because I paid any premiums prior to 12/31/10, but only because I paid the 1/1/11 premium. It is this 1/1/11 premium payment that kept the policy in force. (And it might actually be viewed as a "new" policy, completely separate from the old one(s)). That is, had I not made the 1/1/11 premium payment, the policy would have lapsed.

Doug M (talk|edits) said:

23 October 2011
I dunno. I had an agent of a client of mine suggest this last year for a DI policy. He was suggesting that at the end of the year, if there was no disability, deduct it. If there was, put the premium on the W-2. In other words, look at the issue on a year to year basis, not cumulative.

I know that the examples in Reg. 1.105(c)(1) uses the current year.

TC Memo 1989-203 (Dzioba 57 TCM 283, Dec. 45,657(M) suggests looking beyond the current year.

I have looked but could not find the example for DI where it looked at premiums over the life of the policy.

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