Disability Income Coverage

<div class="Section1">Yes. The IRS has ruled that premiums paid on an overhead expense disability policy, a special type of contract that reimburses professionals or owner-operators for overhead expenses actually incurred during periods of disability, are deductible as a business expense and the proceeds are taxable.<a href="#_ftn1" name="_ftnref1">¹</a> The ruling relates to self-employed individuals.<div class="Section1"><br /> <br /> Premiums paid on standard personal disability insurance are not deductible as a business expense but the proceeds are tax-exempt as compensation for personal injuries or sickness ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="382">382</a>).<a href="#_ftn2" name="_ftnref2">²</a> This is true even though a taxpayer intends to use the benefits to pay overhead expenses during periods of disability.<a href="#_ftn3" name="_ftnref3">³</a> (<em>See</em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="377">377</a>.)<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp; Rev. Rul. 55-264, 1955-1 CB 11.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp; Rev. Rul. 55-331, 1955-1 CB 271; Rev. Rul. 70-394, 1970-2 CB 34.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp;&nbsp;&nbsp; Rev. Rul. 58-480, 1958-2 CB 62; <em>Blaess v. Commissioner</em>, 28 TC 710 (1957); <em>Andrews v. Commissioner</em>, TC Memo 1970-32.<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> Yes. A qualified profit sharing plan may provide health insurance benefits for its employee-participants within limits ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3830">3830</a>). A qualified pension plan may provide disability pensions, but will not qualify if it provides regular health insurance benefits for active employees. A qualified pension plan may provide health insurance benefits for retired employees ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3830">3830</a>). For tax consequences to employees, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="394">394</a>&nbsp;and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3941">3941</a>.<br /> <br /> </div><br />

<div class="Section1">An employer generally can deduct all premiums paid for disability income coverage for one or more employees as a business expense.</div><br /> <div class="Section1"><br /> <br /> Premiums are deductible by an employer whether coverage is provided under a group policy or under individual policies. The deduction is allowable only if benefits are payable to employees or their beneficiaries; it is not allowable if benefits are payable to an employer.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> The deduction of premiums paid for a disability income policy insuring an employee-shareholder was prohibited where the corporation was the premium payor, owner, and beneficiary of the policy. The Tax Court held that IRC Section 265(a) prevented the deduction because the premiums were funds expended to produce tax-exempt income. The Tax Court stated that disability income policy benefits, had any been paid, would have been tax-exempt under IRC Section 104(a)(3).<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.     Treas. Reg. § 1.162-10(a); Rev. Rul. 58-90, 1958-1 CB 88; Rev. Rul. 56-632, 1956-2 CB 101.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.     <em>Rugby Prod. Ltd. v. Commissioner</em>, 100 TC 531 (1993). <em>See</em> Rev. Rul. 66-262, 1966-2 CB 105.<br /> <br /> </div>

<div class="Section1">Premiums for non-medical care, such as personal disability income coverage, are not deductible.<a href="#_ftn1" name="_ftnref1">¹</a> Only premiums for medical care insurance are deductible as a medical expense ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="342">342</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="487">487</a>).<div class="Section1"><br /> <br /> A deduction is allowed for medical care that is not otherwise compensated for by insurance. The deduction is allowed to the extent that the medical care expenses exceed 7.5 percent of the taxpayer&rsquo;s adjusted gross income. The 10 percent limit was permanently reduced to 7.5 percent in 2020. The threshold is 7.5 percent for the alternative minimum tax.<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect; 213(d)(1).<br /> <br /> </div></div><br />

<div class="Section1">Disability payments from a qualified plan receive different tax treatment, depending on whether the payments are made to common law employees (<em>see</em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="384">384</a>) or to self-employed individuals.<div class="Section1"><br /> <br /> If a self-employed individual draws benefits from a plan because of permanent disability, the disability payments will be taxed under the same rules that apply to retirement benefits ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3969">3969</a>).<br /> <br /> If a self-employed individual receives disability payments through health insurance, the employee may exclude from gross income any amounts attributable to nondeductible contributions as a self-employed person.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> Where contributions under a qualified plan are applied to provide incidental accident and health insurance for a self-employed individual, the insurance is treated as if the employee had purchased it directly from the insurance company.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect;&sect; 105(g), 104(a)(3); Treas. Reg. &sect;&sect; 1.105-1(a), 1.105-5(b).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect; 1.72-15(g).<br /> <br /> </div></div><br />

<div class="Section1">Much like a traditional IRC Section&nbsp;529 college savings plan, ABLE account distributions must be used to fund certain specified expenses of the disabled beneficiary or will become subject to a 10 percent penalty tax. In addition to the 10 percent penalty, any distributed earnings are taxed at the individual&rsquo;s normal income tax rate if the distribution is not used for qualified expenses.<a href="#_ftn1" name="_ftnref1">¹</a><div class="Section1"><br /> <br /> The range of qualified expenses is broad, and includes &ldquo;expenses related to the individual&rsquo;s disability,&rdquo; such as expenses for health care, housing, transportation, job training, assistive technology, personal support, financial management, legal fees and related services and expenses.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> Individuals are generally limited to establishing only one ABLE account. Amounts initially contributed to an ABLE account can be rolled over into another ABLE account established either for the same beneficiary, or for a sibling of that beneficiary who also meets the eligibility requirements discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="386">386</a>. <em>See</em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="388">388</a> for a discussion of changes to the contribution limits and rollover rules that impact ABLE accounts under the 2017 tax reform law.<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp; H.R. 647, &sect; 102.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp; H.R. 647, &sect; 102.<br /> <br /> </div></div><br />

<div class="Section1">Benefits from personal disability income coverage typically are entirely exempt from income tax. There is no limit on the amount of benefits, including the amount of disability income that can be received tax-free under personally paid disability income coverage.<a href="#_ftn1" name="_ftnref1">¹</a><div class="Section1"><br /> <br /> If benefits are received under a plan to which both an employer and employee have contributed, the portion of the disability income attributable to the employee&rsquo;s contributions is tax-free ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="380">380</a>).<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect; 104(a)(3); Rev. Rul. 55-331, 1955-1 CB 271, modified by Rev. Rul. 68-212, 1968-1 CB 91; Rev. Rul. 70-394, 1970-2 CB 34.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect; 1.105-1(c).<br /> <br /> </div></div><br />

<div class="Section1">The Achieving a Better Life Experience (ABLE) Act was included within the Tax Increase Prevention Act of 2014.<a href="#_ftn1" name="_ftnref1">¹</a> The ABLE Act introduced a new type of tax-advantaged savings account that is specifically designed to address some of the challenges to saving that disabled individuals have faced in recent years.<div class="Section1"><br /> <br /> Under the previously existing rules, disabled individuals were often discouraged from accumulating assets to meet future expenses because, absent the use of certain trust vehicles, the individual would be disqualified from receiving Social Security and Medicaid benefits if accumulated assets were worth more than $2,000.<br /> <br /> The ABLE Act modifies these rules to allow individuals to accumulate up to $100,000 in savings accounts called &ldquo;ABLE accounts&rdquo; without becoming disqualified from receiving Social Security benefits (above and beyond the traditional $2,000 resource limit, so that a total of $102,000 can be accumulated without risk of disqualification). Medicaid benefits will not be impacted regardless of how much the individual deposits into the ABLE account.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> In order to qualify as an ABLE account beneficiary, the individual must have been diagnosed with a disability that causes severe limitations before that individual reaches age 26. Beginning in 2026, this age will increase to age 46 under the SECURE Act 2.0. Individuals who are currently receiving Social Security disability benefits also qualify. Regardless, eligibility for Social Security benefits is not a requirement for establishing an ABLE account&mdash;a severe, diagnosed disability is sufficient.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> The ABLE account program is entitled to rely upon a certification of the beneficiary&rsquo;s eligibility that is either signed by the beneficiary or the person establishing the ABLE account. That certification must state that the beneficiary (1) has a qualifying disability that results in marked and severe functional limitations (whether physical or mental) that can be expected to result in death or can be expected to last for a continuous period of at least 12 months or (2) is blind. The certification must also confirm that the disability or blindness occurred before the beneficiary turned 26 and that the beneficiary has (and will retain) a diagnosis that was signed by a physician.<br /> <br /> <em>See</em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="388">388</a> for a discussion of changes to the contribution limits and rollover rules that impact ABLE accounts under the 2017 Tax Act.<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp; H.R. 647.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp; H.R. 647, &sect; 103.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp;&nbsp;&nbsp; H.R. 647.<br /> <br /> </div></div><br />

<div class="Section1">Whether a purchaser, policyowner, beneficiary, or premium payor is the business entity, as in an entity purchase agreement, or the business owner, as in a cross-purchase agreement, the premiums are nondeductible and the proceeds are exempt from regularly calculated income tax ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="377">377</a>).<a href="#_ftn1" name="_ftnref1">¹</a><div class="Section1"><br /> <br /> Where a buy-out occurs between a corporation and a disabled shareholder, if the transaction qualifies as a complete redemption of all the shareholder&rsquo;s shares, the redemption will be treated as a capital transaction ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="300">300</a>). That is, the transaction will be considered the sale of a capital asset and the selling shareholder&rsquo;s gain or loss will be measured and taxed. A disability buy-out between shareholders also is a capital transaction and is taxed accordingly.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> Where a buy-out occurs between a partnership and a disabled partner, resulting in a termination of the disabled partner&rsquo;s interest, the transaction is taxed under the rules applying to a liquidation of a partner&rsquo;s interest ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="311">311</a>).<br /> <br /> Where a buy-out occurs between partners, the transaction is taxed under the rules applying to a sale of a partner&rsquo;s interest ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="311">311</a>).<br /> <br /> When a disabled business owner realizes gain on the sale of his or her business interest, the amount of gain is includable in his or her gross income in the taxable year in which the gain is actually or constructively received unless the gain is includable in a different year due to the taxpayer&rsquo;s method of accounting.<a href="#_ftn3" name="_ftnref3">³</a> If a sale qualifies as an installment sale, a pro rata portion of the gain is reportable for each taxable year installment payments are received.<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect;&sect; 104(a)(3), 265(a)(1); Rev. Rul. 66-262, 1966-2 CB 105.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect;&sect; 61(a)(3), 1001, 1011, 1221, and 1222.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect; 1.451-1(a).<br /> <br /> </div></div><br />

<div class="Section1">A corporation cannot deduct premiums it pays but can exclude insurance benefits from its gross income.<a href="#_ftn1" name="_ftnref1">¹</a> Disability income, regardless of amount, is wholly tax-exempt to the corporation under IRC Section&nbsp;104(a)(3).<a href="#_ftn2" name="_ftnref2">²</a> Because the disability income is tax-exempt, a deduction for premiums is disallowable under IRC Section&nbsp;265(a)(1) on the ground that the premiums are expenses paid to acquire tax-exempt income.<a href="#_ftn3" name="_ftnref3">³</a> An accidental death benefit may be tax-exempt to a corporation under IRC Section&nbsp;101(a) as death proceeds of life insurance ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="63">63</a>). Premiums paid for tax-exempt accidental death coverage are nondeductible under IRC Section&nbsp;264(a)(1) ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="262">262</a>).<div class="Section1"><br /> <br /> On January&nbsp;16, 2009, the Office of Associate Chief Counsel (Income Tax &amp; Accounting) issued Chief Counsel Advice<a href="#_ftn4" name="_ftnref4">⁴</a> concluding that a taxpayer may not take a deduction under Section&nbsp;162 for compensation paid to an employee pursuant to an employment contract, because the taxpayer was receiving disability insurance payments on account of the employee&rsquo;s injury and Section&nbsp;162 disallows a deduction for an expense for which there is a right or expectation of reimbursement.<br /> <br /> However, upon further consideration, the Office of Associate Chief Counsel (Income Tax &amp; Accounting) concluded, based upon the facts in the prior CCA, that a taxpayer is not precluded from taking a Section&nbsp;162 deduction for compensation paid to an employee pursuant to the employment contract merely because the taxpayer received insurance payments on account of an employee&rsquo;s disability. Nor does Section&nbsp;265(a)(1) disallow such a deduction.<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp; Rev. Rul. 66-262, 1966-2 CB 105.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp; <em>Castner Garage, Ltd. v. Commissioner</em>, 43 BTA 1 (1940).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp;&nbsp;&nbsp; <em>Rugby Prod. Ltd. v. Commissioner</em>, 100 TC 531 (1993).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp;&nbsp;&nbsp;&nbsp; CCA POSTF-135262-08.<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRS Office of Chief Counsel Memorandum No.&nbsp;200947035, Nov.&nbsp;20, 2009.<br /> <br /> </div></div><br />