How to Insure Your Income: A Workers' Comp Policy

Insurance companies don't have to use a standard workers' comp policy form -- which makes general coverage analysis difficult. However, the National Council on Compensation Insurance (NCCI) -- a Florida-based trade group -- has developed a standard policy, and it is followed by many companies in most cases.

The standard NCCI policy provides a complete package of protection for an employer's obligations under workers' compensation law and liability that is outside that law.

The coverage applies only to statutory benefits (those required by law). The insurance company agrees to pay promptly when due the benefits required of the insured by state workers' compensation laws.

Certain payments will be the sole responsibility of the insured employer and not the insurance company. These are usually fines or damages related to illegal behavior, willful misconduct or failure to comply with health and safety regulations.

Some general legal provisions apply. Among these:

• the employer and insurance company are one and the same, with regard to notice of injury given by a worker and with respect to matters of legal jurisdiction;
• bankruptcy of the employer will not relieve the insurer of its policy obligations; and
• the insurance company agrees to be directly and primarily liable to anyone entitled to insurance benefits.

The standard policy also will provide some employers' liability coverage for related claims that fall outside the technical limits of workers' comp.

In recent years, successful suits against employers also have been filed by spouses and children of injured workers. Employers' liability insurance covers these claims if the original suit is brought in the U.S., its territories or possessions or Canada.

Injuries to workers covered by federal laws are excluded, because the policy is designed to cover exposures that are subject to state jurisdiction, but coverage for many of these exposures may be added to a policy by endorsement.

Workers who load, unload, build or repair ships are covered by the U.S. Longshore and Harbor Workers' Compensation Act. Miners may require Federal Black Lung Compensation insurance. Federal law enforcement officers are covered by specific laws.

Since many occupational diseases are slow to de-velop -- such as asbestosis, silicosis and diseases associated with radiation exposure -- several administrative problems can result:

• a worker may be employed by several employers and be under a constant disease exposure;
• the disablity may take place sometime after the last injurious exposure; or
• due to the time involved, several different carriers may cover workers' compensation for the same employer.

There also can be some overlap between workers' comp and long-term disability benefits -- and some question concerning benefits and income tax. For example, the 1995 United States Tax Court decision Bruce and Barbara Clausse v. Commissioner of Internal Revenue dealt with the issue of whether or not workers' comp and related disability benefits are subject to federal income tax.

In February 1976, Bruce Clausse was diagnosed with Chrohn's disease, which causes inflammation of the digestive system. At the time, he was working as a deputy sheriff in the Sacramento County (California) Sheriff's Department. Both the Workers' Compensation Board and the Sheriff's Department determined that Clausse's disability was sustained within the course of his employment.

The disability entitled him to receive long-term disability benefits through a group insurance policy underwritten by Standard Insurance Co. Clausse had been receiving disability income from this policy since February 1976.

From February 1976 to March 1990, Clausse also received workers' comp benefits, in addition to the monthly disability insurance payments. When his workers' comp award was exhausted, he began receiving life pension benefits from the county. At the time of the trial, he was receiving both the pension benefits and the disability insurance payments.

During 1990, Clausse received $8,733.60 in disability insurance payments. At year-end, Standard Insurance issued Clausse an IRS Form W-2P, Statement for Recipients of Annuities, Pensions, Retired Pay or IRA Payments. This classified the payments as taxable income.

The Clausses reported the payments as non-taxable income on their 1990 federal income tax return. In prior years, the couple had reported the disability payments in this fashion and -- in audits for prior years -- the IRS had agreed that these payments were not includable in gross income.

However, in this case, the IRS determined that the disability insurance payments were includable in gross income, and issued a notice of deficiency. (As a result of this determination, the IRS also made adjustments to the Clausses' itemized deductions for medical and dental expenses.)

For Clausse's disability payments to qualify for exclusion from gross income for tax purposes, it would be necessary to first establish that the disability payments were received under either a workers' comp act or under a statute that is in the nature of a workers' comp act. After that, it would be necessary to establish that the disability benefits were received for an injury sustained in the course of employment.

The court found that the Clausses presented no evidence to establish that the disability insurance payments were paid pursuant to the federal and state statutory provisions they had cited. On the contrary, in a joint exhibit stipulated into evidence, Standard Insurance stated that the payments to Bruce Clausse were not paid pursuant to either law -- but had been paid by the company as third-party sick pay.

Moreover, if the disability insurance payments were made pursuant to a statute considered to be in the nature of a workers' comp act, such statute would have to limit the disability benefits to job-related injuries. Furthermore, for the statute to be considered "in the nature of a workmen's compensation act," it must preclude an employee from filing an independent claim for workers' comp benefits.

In Clausse's case, the disability insurance policy provided for payments to be made regardless of whether the injury or disability arose in the course and scope of employment. In addition, the insurance policy itself stated that "Long Term Disability Insurance is not in lieu of and does not affect any requirement for coverage by workmen's compensation insurance."

Clausse clearly was not precluded from filing an independent claim for workers' comp benefits, since he had received those benefits for 14 years while also receiving the disability benefits.

Therefore, the court held that the disability insurance payments received during 1990 were not received under a workers' comp act. As such, they counted as gross income for tax purposes.

The court did note that it was sympathetic to the fact that the Clausses were informed by the IRS during several audits for prior years that the disability payments were not includable in gross income. However, the fact that the IRS overlooked or accepted the tax treatment of the disability payments in previous years did not preclude it from correcting that error in subsequent years with respect to the same taxpayers.

In the end, the Clausses had to pay $1,673 in 1990 federal income tax on the disability benefits.