L—Disability Income Plan

When a disabled employee is faced with increasing expenses and decreasing income, some employers will informally continue the disabled employee's salary for an extended period of time. Such an approach can be unwise when the disabled employee is a stockholder. To illustrate, assume that a corporation’s income is $150,000 before paying a $50,000 salary to its employee-stockholder.

NO PLAN.If this employee-stockholder becomes disabled without a pre-existing plan, continued salary payments of $50,000 could be treated by the IRS asnondeductible dividends, which must come from after-tax profits. Assuming the taxable income of the business does not suffer because of the key employee’s disability, taxable income would then be $150,000, upon which $31,500 (assuming a flat 21 percent tax rate) of taxes must be paid, with $68,500 remaining after-tax and after payment to the disabled stockholder-employee.

PLAN.A pre-existing disability income plan would enable the corporation to preserve the tax-deductibility of these continued salary payments to the disabled employee-stockholder. This would place the corporation in the same position as existed prior to the employee-stockholder’s disability.