Understanding how disability premiums work is essential for both employers and employees. These decisions affect compliance, support during difficult times, and the taxability of benefits. Whether you’re dealing with short-term disability (STD) or long-term disability (LTD), here’s what you need to know.

Taxability of Disability Payments

The tax treatment of disability benefit payments hinges on who pays the premiums and how they are paid.

Here’s a quick breakdown:

• Taxable Benefits: Payments are taxable when:
  • Employees pay premiums with pre-tax dollars, or
  • Employers pay premiums and do not include those amounts in the employee’s taxable wages on the employee’s Form W-2.

• Non-Taxable Benefits: Payments are not taxable when:
  • Employees pay premiums with post-tax dollars, or
  • Employers pay premiums and do include those amounts in the employee’s taxable wages on their Form W-2.

Structuring your plan to allow for post-tax employee premium payments can ensure benefits are tax-free when needed. While employees may feel the tax impact upfront, they will appreciate the tax-free income during a disability event. Employees should confirm how premiums are paid and consider post-tax contributions if available.

Working with Third-Party Sick Pay Providers
Many employers outsource the administration of short- and long-term disability benefits to third-party providers. While this simplifies claims processing, it can complicate tax reporting. Typically, the third party handles most withholding and reporting obligations. However, generally the employer is still responsible for reporting sick pay benefit payments made by a 3^rd party and any withheld income tax on Form 941. The employer would also file need to file Form 8922 to reconcile the employee’s Form W-2 and any Forms 941 filed by the employer.

Shared Contribution Plans
If both the employer and employee paid disability premiums, only the employer-funded portion of benefits is taxable. Use the three-year lookback rule to determine the taxable percentage.
For example, if the employer paid 70% of premiums over the past three years, then 70% of the benefit is taxable and should be reported accordingly.

Conclusion

Managing disability premiums is not merely an administrative task; it is a commitment to supporting employees during life’s unexpected challenges. By understanding the tax implications and structuring benefits strategically, employers can build a program that truly supports their team.

Most importantly, employers should educate employees on how their premium contributions affect benefit taxability. Employees should take an active role in understanding their coverage. Stay proactive, keep detailed records, and review policies regularly, as tax laws and reporting responsibilities can change.

If you have any questions, don’t hesitate to reach out to your advisors at Snyder Cohn for more insights and guidance.

By: Zane Sanchez