Taxation of premiums and benefits
A note: Some students know very little about taxes and the vocabulary associated with it. That's OK. Simply put, the government is going to get their money one way or the other. If something is tax deductible, that means the government did not get their money. But, if and when the benefit is paid out, the benefit would then be taxable. Pay attention to the words:
- Tax deductible
- Taxable
- Premium vs benefits
- Employer vs Employee
- Individual vs Group
MR. WATSON: Disability Benefits, are they taxable or not taxable?
- Individual - benefits usually tax free
- Group - benefits are usually taxable
MR. WATSON: The premium will be the same for both the individual and the group in our example. The same individual is going to pay $1,000 a year for a $5,000-a-month benefit for his disability policy. For group, the business is going to buy for you a $1,000-a-year premium for your group disability. Group disability, if you become disabled you will receive $5,000 a month.
MR. WATSON: One is individual, one is group. With individual the employee cannot tax-deduct it, so the benefit would not be taxable. The benefit is tax free.
MR. WATSON: With group, the business is paying the premium for you. The business gets to tax-deduct it as a legitimate business expense. When the benefit is paid out, it's taxable on the right.
MR. WATSON: Now, if the business is paying 80 percent of the premium for you & you are paying the other 20 percent, it's a contributory plan. The employee is contributing to the premium.
MR. WATSON: How much do I get to tax-deduct as a business owner?
ALL: 100 percent.
MR. WATSON: If the business is only paying 80 percent of the premium, they can't tax-deduct 100%. How much do they get to tax-deduct?
ALL: 80 percent. The amount the business is paying.
MR. WATSON: How much does the employee get to tax-deduct?
ALL: Nothing.
MR. WATSON: Individuals cannot tax-deduct what they put into their group contributory plans. So how much is the business owner, tax deducting?
ALL: 80 percent.
MR. WATSON: How much is the employee deducting?
ALL: None.
MR. WATSON: When the benefit is being paid out, how much is tax-free to you?
ALL: 20 percent, because that represents the amount that is not tax deductible.
MR. WATSON: How much is taxable to you?
ALL: 80 percent.
WOMAN: That's disability income insurance?
MR. WATSON: Disability insurance.
WOMAN: Oh.
MR. WATSON: You okay?
WOMAN: No, because my husband has disability, and his is nontaxable, all of it, and he was paid as a group. He was a firefighter.
MR. WATSON: Well, then, they didn't tax-deduct it when they put it into his plan.
WOMAN: That will be hard for me to remember.
MR. WATSON: No, it isn't. If they don't tax deduct it when they put it into his plan originally, then they've paid the taxes on it and the benefit will not be taxable. If they tax-deducted it in the beginning, then Uncle Sam didn't get his money which would make the benefit taxable. You agree?
WOMAN: Yeah.
MR. WATSON: So for your husband to get his disability payment free of taxes, then they could not have tax-deducted any of it.
WOMAN: So the fire department, city, whatever, doesn't take it as a tax deduction?
MR. WATSON: Exactly. Because if they did, what would your husband have to do?
WOMAN: Pay taxes.
MR. WATSON: This is federal.