Health Insurance Mastery Practice Exam

When a group disability insurance plan is funded entirely by the employer, what are the tax implications for employees?

1. Benefits are tax-exempt

2. Benefits are taxable income to the employee

3. Employees pay taxes on earned premiums

4. Benefits are taxed at a reduced rate

The correct answer is: Benefits are taxable income to the employee

When a group disability insurance plan is funded entirely by the employer, the tax implications for employees indicate that benefits are considered taxable income to the employee. This situation arises because the premiums for the disability insurance policy are paid by the employer, meaning that when employees receive benefits from this plan, those benefits are treated as income. Since the employees did not contribute to the premium payments, the Internal Revenue Service (IRS) categorizes the benefit payments as taxable income, which the employees will need to report on their tax returns. This taxation occurs because the employee does not have the tax advantage that comes with paying for the premiums personally, which would allow for tax-free disability income under other circumstances. If the premiums were to be paid with after-tax dollars (i.e., the employee contributes), the benefits could be received tax-free. Understanding this aspect is crucial for employees to accurately prepare for the implications of receiving disability benefits through employer-funded plans.