228 / If a corporation attaches a disability income rider to a key person life insurance policy, what are the tax consequences to the corporation and to the key person?
Where the employee is a designated payee of the disability income, the tax consequences are uncertain. However, it would seem that the disability rider should be treated as accident and health insurance, separable from the life insurance, and that the results would be as follows: the corporation could deduct, as a business expense, the premiums paid for the disability income coverage;1 the premiums would not be taxable to the key person;2 and the disability income would be taxable to the key person.3 A tax credit may be available to the key person.
If the disability income is payable to the corporation, the corporation cannot deduct the premium payments,4 but the disability income is tax-exempt to the corporation.5 If the corporation uses the disability income to make disability retirement payments to the key person, it would seem that the corporation could deduct the payments as a compensation expense. The payments would be taxable to the key person,6 but the key person might be eligible for a tax credit.
1. IRC § 162(a).
2. IRC § 106(a).