PLR 200146011: Disability benefits follow the employee's annual premium election

Plain-English summary

An employer proposed allowing employees to elect each year whether to bear the full cost of long-term disability coverage on an after-tax basis. The IRS ruled that benefits for an employee who made that election for the year disability began would be excluded from income under section 104(a)(3). If the employee instead received employer-paid coverage without including its cost in income for that year, the benefits would be taxable under section 105(a). The ruling treated each employee's coverage as funded entirely by either the employee or the employer, depending on that year's election.

Ruling snapshot

• Question: How does the annual premium election affect the tax treatment of long-term disability benefits?
• Outcome: Benefits from after-tax employee-funded coverage are excluded; benefits from employer-funded coverage are included in income.
• Key authorities: IRC §§ 104(a)(3), 105(a); Treas. Reg. §§ 1.104-1(d), 1.105-1.

Full text (IRS public release)

INTERNAL REVENUE SERVICE

Number: 200146011
Release Date: 11/16/2001
Index No. 104.01-00

CC:TE/GE:EB:HW PLR-110311-01

June 25, 2001
Taxpayer =

Plan =

Dear
:

This is in reply to your letter dated January 4, 2001, and subsequent correspondence, requesting rulings on behalf of Taxpayer concerning the Federal income tax treatment under sections 104 and 105 of the Internal Revenue Code (the Code) of long-term disability benefits paid through the Plan.

You represent that Taxpayer provides long-term disability coverage to its eligible U.S. employees through the Plan. Benefits are provided through a group insurance policy with a third-party insurance carrier. The Plan currently provides employees, who become disabled while employed with wage continuation payments at the rate of 66.67% of salary after an initial 180-day Elimination Period. Under the current terms of the Plan, Taxpayer covers the entire premium for this basic coverage, and the cost of coverage is not included in the gross income of the employees.

Taxpayer intends to amend the Plan to provide that each employee (whether current or hired in the future) may elect to pay the full cost of his or her long-term disability coverage on an after-tax basis (the Amended Plan). While the Taxpayer will continue to meet in-full the group policy insurance premiums charged by the third-party carrier for each employee, an appropriate portion of the group premium will be allocated to each employee who elects to meet the cost of coverage on an after-tax basis and will be included in his or her gross income reported each year.

Under the Amended Plan, the election to pay for the cost of coverage on an after-tax basis may be made on a year by year basis and must be made in writing prior to the beginning of the Plan year during which the employee will be paying for his or her disability coverage on an after-tax basis. The election is irrevocable for the Plan year once the Plan year begins. Employees hired during the course of a Plan year will be

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permitted to elect after-tax coverage for the remainder of the Plan year within a certain period (generally, 30 days) following their employment commencement date. Employees will be permitted to make a new election for each Plan year prior to the beginning of that Plan year.

Section 104(a)(3) of the Code provides that, except in the case of amounts attributable to (and not in excess of) deductions allowed under section 213 for any prior taxable year, gross income does not include amounts received through accident or health insurance (or through an arrangement having the effect of accident or health insurance) for personal injuries or sickness (other than amounts received by an employee to the extent such amounts are attributable to contributions by the employer which were not includible in the gross income of the employee, or are paid by the employer).

Section 1.104-1(d) of the Income Tax Regulations states that if an individual purchases a policy of accident or health insurance out of his own funds, amounts received thereunder for personal injuries or sickness are excludable from his gross income under section 104(a)(3). Conversely, if an employer is either the sole contributor to such a fund, or is the sole purchaser of a policy of accident or health insurance for his employees, the exclusion provided under section 104(a)(3) does not apply to any amounts received by his employees through such fund or insurance. The regulation refers to section 1.105-1 of the regulations for rules relating to the determination of the amount attributable to employer contributions.

Section 1.105-1(b) of the regulations provides that all amounts received by employees through an accident or health plan which is financed solely by their employer are subject to the provisions of section 105(a).

Amounts received by an employee through accident or health insurance for personal injuries or sickness must be included in gross income under section 105(a) of the Code to the extent such amounts (1) are attributable to contributions by the employer which were not includible in the gross income of the employee, or (2) are paid by the employer, unless paid as reimbursements of medical expenses under section 105(b) or for the loss or loss of use of a member or function of the body and without regard to absence from work under section 105(c).

Section 1.105-1(c)(1) of the regulations provides that in the case of amounts received by an employee through an accident or health plan which is financed partially by his employer and partially by contributions of the employee, section 105(a) of the Code applies to the extent that such payments are attributable to contributions of the employer that were not includible in the employee’s gross income. The portion of such amounts which is attributable to such contributions of the employer shall be determined in accordance with section 1.105-1(d) in the case of insured plans.

With respect to each employee, the Amended Plan is financed either solely by the Taxpayer or solely by the employee. At no time is the coverage under the Amended Plan financed by both Taxpayer and employee contributions. Accordingly, the Amended Plan is not a contributory plan within the meaning of section 1.105-1(c)(1) of the regulations.

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Based on the information submitted and representations made, we conclude as follows:

(1) Long-term disability benefits paid to an employee who has elected, under the Amended Plan, to pay his or her own premiums on an after-tax basis for the Plan year in which he or she becomes disabled, are attributable solely to after-tax employee contributions and excludable from such employee’s gross income under section 104(a)(3) of the Code.

(2) Long-term basic disability benefits paid to an employee who has elected, under the Amended Plan, to exclude the premiums paid by the Taxpayer for the Plan year in which he or she becomes disabled, are attributable solely to Taxpayer contributions and includible in such employee’s gross income under section 105(a) of the Code.

This ruling is directed only to the taxpayer who requested it. Section 6110 (k)(3) of the Code provides that it may not be used or cited as precedent.

Sincerely yours,
Harry Beker, Chief
Health and Welfare Branch
Division Counsel/Associate Chief Counsel (Tax Exempt and Government Entities)

Enclosures:
Copy of this letter
Copy for section 6110 purposes